Outsourcing contracts shrink says TPI

Technology Partnerships International says that many companies are awarding smaller outsourcing contracts because of increased use of offshore locations.

The latest quarterly index from the sourcing advisory firm shows the average value of larger contracts signed worldwide to date in 2005 is 183m, down by almost a quarter from 240m a year ago.

The trend is particularly intense in the European market, where average contract value is down 37% on this point in 2004.

It also appears to be gaining momentum, with the average contract value in the last quarter only a third of the average value in the same quarter of last year.

However, the number of outsourcing contracts continues to rise, being 11% higher than it was a year ago.

TPI attributes the trend to smaller deals to three principal factors. Firstly, the impact of price competition, due to the increasing use of offshore resources and the associated lower labour costs.

Secondly, a typically lower capital component, because contracts are less likely to involve the transfer of assets to the outsourcing vendor.

And thirdly, a growing tendency to select more specialist providers, which is particularly significant as in the past two years 80% of deals have focused on a single process or function, compared with only 65% three or four years ago.

Duncan Aitchison, managing director of TPI, says: “Contracts are becoming increasingly specialised with many companies choosing to outsource single functions, such as accounts payable or desktop support, selecting a best-of-breed provider for each.

“This trend to a larger number of smaller contracts is creating opportunities for a wider range of providers and driving increased competition to the benefit of outsourcing purchasers. Indian providers in particular are enjoying growing success.

“As the recent ABN Amro deal demonstrates, Indian providers can also now compete for and win the biggest application development and maintenance contracts.”

The trend to smaller average contract values is further evidenced by only eight mega deals (contracts valued at over 800 million) having been signed this year compared with thirteen by this point in 2004.

Moreover, a growing proportion of these mega deals are restructurings rather than entirely new contracts – a record 38% of those signed so far this year were restructurings.

TPIs figures also show that the use of offshore locations continues to increase. Very little information is available on the breakdown of outsourcing between onshore and offshore operations.

However, an examination of deals on which TPI has advised shows that 44% of contracts signed so far this year involved offshore components or global service delivery, up from 40% in 2003 and 2004.

According to TPI, more BPO than ITO deals now have offshore components a reversal of the norm in previous years.

Aitchison says: “It seems that BPO clients are becoming increasingly comfortable with work being performed by offshore providers. More than ever, we are seeing clients embrace global service delivery and the question is no longer whether to offshore, but which functions are best delivered from which location.”

Impending contract renewals could shake up service providers market share

TPI data also reveals that a considerable number of outsourcing contracts awarded in the last seven to 10 years are now nearing an end. The company estimates that 128 contracts, originally valued at over 32bn, are coming up for renewal in 2006. Over 70% of this potential contract value is under contract to CSC, EDS and IBM.

Although, it is not yet certain how competitive the contract renewals will be for these incumbents, TPI experience suggests that about 25% are competitive and that the proportion is increasing.

Aitchison says: “With such a significant volume of outsourcing contracts nearing their renewal date, 2006 could witness interesting shifts in the market share of the Big Six and other providers. Although contract lengths are declining, success or failure could have implications for a vendors market position for years to come.”