Outsourcing Opportunities Opening Up for Smaller Vendors

It used to be that most IT outsourcing agreements went to the largest providers in the form of "mega-deals" worth more than $1 billion. The logic behind these agreements was that a one-stop-shop like IBM could use its extensive expertise to run a company’s entire IT function.

According to a detailed analysis of outsourcing marketing provided by Gartner, a Stamford, Connecticut-based research firm, there’s been a shift in thinking. Their database of outsourcing deals announced publicly shows that the average IT outsourcing deal involves smaller amounts of money than in previous years.

The trend, according to Gartner, is away from "mega-deals" in favor of "multisourcing" agreements where the work is divided among multiple providers that bring "best-of-breed" skills to the project. Since smaller software firms are most likely to be "best-in-breed" within their individual segment, opportunities for smaller software firms are on the rise.

Gartner’s data reveals that the number of comprehensive, end-to-end contracts signed with a single vendor has declined from 16 in 2003 to 12 in 2004 to 11 in 2005. Gartner’s analysts see this decline as part of a trend in which most business process outsourcing (BPO) activity will take place as smaller, more focused deals, primarily in the human resources, finance, and accounting sectors.

More importantly, although the contract value of individual outsourcing deals continues to decrease, the overall amount of outsourcing will continue to increase at a growth rate of 7.3 percent from 2004 through 2009. The uptake in outsourcing as a business tool will continue and experience mature growth in 2006 at 5.1 percent, while the less-mature BPO segment will grow faster at 8.7 percent in 2006.

Despite the decline, mega-deals represent a significant share of total outsourcing contract value, averaging $25.3 billion per year between 2003 and 2005 – roughly 52 percent of publicly reported outsourcing contract value. However, in the near future, increasing numbers of outsourcing deals will occur in the $100 million to $999 million range, thereby opening opportunities for a wider variety of IT providers.

Gartner notes that contract term lengths are also on the decline. The average length of an IT outsourcing contract declined from 6.2 years to 5.3 years from 2003 through 2005, while the average length of a BPO contract declined from 5.5 years to 4.8 years during the same period. When measured independently by year and type of outsourcing, the median length is consistently five years.

Declining asset lifecycles, constant business changes, cost, innovation, and cultural/business fit are affecting the contract length in the life of an outsourcing relationship. In other words, organizations want shorter contracts with flexibility that won’t lock them in, thereby opening more opportunities for smaller vendors to enter into a competition for these lucrative contracts.

Additional information is available in the Gartner report, "Market Trends: Outsourcing Contracts, Worldwide, 2005," available on Gartner’s Website at www.gartner.com.