by Stephanie Overby

Outsourcing Industry Mergers Spell Bad News for IT

Oct 21, 2009
IT LeadershipMergers and AcquisitionsOutsourcing

The forecast calls for more mergers in the IT outsourcing industry and that means more headaches for IT groups. Brace yourself for decreased competition, increased service disruption, and other woes, analysts say.

IT services industry watchers say the question is not if, but when the next big merger between outsourcing vendors will happen.

“There will be more consolidation in the ITO industry, and it will occur at every level,” says Mark Robinson, chief operating officer for outsourcing consultancy EquaTerra. That’s good news for some providers and for the industry, but the outlook for customers is cloudy.

“Overall, consolidation tends to concentrate quality and spark innovation,” Robinson says. “However, these benefits to the industry come at a price, and that price includes a reduction in competition and an increased—albeit transient—risk of service quality disruption. The next 24 months will be a period of relative instability in the industry, and you should expect to see other big names make their moves.”

[ Five Steps to Take if Your Outsourcing Provider Is Sold ]

Consequently, customers with large infrastructure outsourcing deals may be nervous, says Charles Arnold, managing director of EquaTerra’s information technology practice. “Most companies employed a single-provider strategy. Companies who chose HP very likely also considered EDS and opted to go the other way for whatever reason,” Arnold explains. “It can be a bitter pill to swallow when your chosen provider changes its stripes.”

Those customers who are shopping around for infrastructure providers may notice a change in their options. “There are now fewer top players to choose from,” Arnold says, “which can limit competition or push buyers into the second tier of providers [who] may not have been invited to the table before.”

Further consolidation on the infrastructure front could also erode customer power at the bargaining table. Arnold notes that in the early days of IT outsourcing, customers didn’t have much leverage when it came to contract negotiation because there were so few providers (and thus, so little competition among them.) But as the number of providers increased, so too did customers’ power over contract negotiations, and customers came to expect “reasonable flexibility on everything from price to service delivery model,” says Arnold. “This has made for a fairer and more competitive marketplace, albeit one with thinner margins than the old days for the providers.”

For that scenario to remain the case, the industry needs at least three to four large providers in competition for contracts, according to Arnold. “If the number of credible contenders for very large deals shrinks too far, the balance will shift again, and buyers may find themselves back in a relatively powerless position.” That is not yet the case.

Questions About Service Quality

Another concern for new and existing customers is transition—both their own and their providers’. “Transition and ongoing operations for an enterprise customer are very large and very complex endeavors,” says Arnold. “The concern is that during this very challenging time for an enterprise buyer, the provider is also undergoing a transformation, one associated with their own integration activities.”

Those with deals already in steady state also could see a “back-slide into transition,” adds Arnold. “As providers seek to claim synergies brought about by the rationalization of service delivery footprints or delivery teams, the client’s own service delivery footprint may be pressured to change,” he says.

Gartner research vice president Dane Anderson says he’s seeing less anxiety about competition or change management than about the ability for these new mega-providers to serve the needs of non-mega deals.

The big outsourcing providers are all paying lip service to the mid-market, which Anderson says may be the “new IT services battlefield.”

“HP, for example, did have a mid-market play and may try to use that to expand the traditional comfort zone of its new EDS brethren,” agrees Arnold. “ACS and Perot Systems both served the mid-market as well, and will not likely shed those roots too quickly.”

The question, says Anderson, is whether the largest providers can scale down the size of certain engagements and still provide a requisite level of attentiveness to clients while maintaining profitability. He also wonders whether smaller deals will enable the growth that these service providers are being pressured to show.

For their part, IT leaders are uneasy about the ability of these new two-headed entities to remain vendor agnostic and to support existing multi-sourced environments, says Anderson.

“The result of the recent consolidation activity in the provider marketplace is that buyers have been pushed back on their heels,” says Arnold. “They can see why the mergers are in the best interest of the providers, but it is more difficult to see how it will improve [their own] value proposition.”

The best plan during this period of change and uncertainty is to know thyself, say the outsourcing analysts. “Determine what the roles, responsibilities and core competencies of the IT organization are,” says Anderson. “As the IT service provider landscape continues to morph and the development of new delivery models and offerings continues to emerge and gain adoption, IT organizations need to determine how, where, if and when these services fit into their operating model.”