Both customers and vendors will be taking a close look at their outsourcing activities in 1999, according to Michael Palma, research analyst for Dataquest, a Gartner Group company. Vendors, cognizant of the high cost of winning bids competitively, will be more selective in the projects on which they bid. On the customer side, he predicts reevaluation of contracts over the next year or two, driven by the fact that approximately 30 percent of outsourcing customers last year reported being either neutral or dissatisfied with their outsourcing arrangements. His third key projection is the continuation of an existing situation — the outsourcing of non-core functions due to a labor-constrained market.
“Customers always have to evaluate what they can do with their in-house staff versus what is better to go to an outside provider for,” says Palma. “And in these situations, they are finding, especially for the infrastructure needs of the organization — the networking, the Internet — that top management is growing rapidly. Those things they can better leverage off the outsourcing vendor’s expertise.”
Palma says the fact that the labor shortage is expected to continue for four or five years has an economic impact on companies and, in turn, on outsourcing. Customers, he says, will find themselves competing for the best IT professionals with other professional service firms and other IT firms.
“These companies tend to win that battle because, for them, these people are their workforce, their capital, and they are willing to throw more money to them,” says Palma, “whereas for normal Fortune 1000 companies, the IT staff is just one component. I think that’s going to be an important driver for the outsourcing market.”
Dealing with a Downturn…
Another factor, he says, is the possible hedge against an economic downturn that outsourcing offers customers. Having predictable costs for the IT infrastructure enables companies to make effective budget decisions, which can affect their valuations.
“Wall Street still continues to focus on short-term profitability and issues for valuating public corporations,” says Palma. “One way to boost profits is to no longer consider IT an asset, but ,in essence, to lease it from an outsourcer. That affects companies’ valuations and helps with their relationship with the stock market and their stockholders, as well as management compensation.”
The Challenge of Globalization
The trend toward mergers and acquisitions and globalization creates another economic factor that is driving outsourcing relationships, according to Palma. As companies move into the global marketplace, they don’t always have the talent pool to build and maintain international networks for information to flow to hub offices.
“If you can partner with a large presence or vendor that specializes in hub communications, it can definitely be cheaper,” he says. “You can have shorter build-out times and shorter deployment times by outsourcing that to a firm that specializes in telecommunications and worldwide projects. They have the experience.”
In looking at industry growth, Palma focuses specifically on IT management services and business management services, two categories used by his company’s forecaster. He says Dataquest expects IT management services outsourcing to grow at a rate of 14.4 percent annually in the U.S., from $26.3 billion in 1997 to $51.6 billion in 2002. On a worldwide basis, the projection for that category rises to 16.3 percent annually, increasing from $57.9 billion in 1997 to $123 billion in 2002.
In business management services, which includes business process management and transaction processing, Dataquest’s forecast calls for a 13.5 percent growth rate over the same period in the U.S., while the worldwide growth rate dips a bit to 12.7 percent. Palma explains that transaction processing, the larger component of that category, is heavily concentrated in IT and growing more slowly, while business process management actually is growing worldwide at a rate of 20.7 percent.
Some of this growth will include new outsourcing activities, according to Palma. He cites application management and enterprise applications that include ERP and other front office customer support solutions as topics that will play more important roles in outsourcing. “The application management of these will become very important to the outsourcing market for more than just a year, probably over a time period of two to three years,” says Palma. “It will be very important to customers and very important opportunities for suppliers.”
He attributes the increase in application management to what he calls ‘a flare-up in the life cycle,’ including the rapid growth of the European market over the past few years. “Then there are first and second-generation projects employing the software, becoming comfortable with it,” he says. “The next logical step after they’ve installed it, deployed it and have it functioning is to look toward managing these processes and solutions for the long term. Some customers will look toward outsourcing the management responsibility of these applications.”
The role of outsourcing in e-commerce also will grow, according to Palma, primarily because of the expertise required to manage the networks. “And the responsibility of verifying the transactions, of processing all the transactions that we think will be taking place, will lead customers to outsourcing,” he says.
At the heart of all this growth are the outsourcing relationships. Palma notes two factors as important to building an effective relationship. The vendor, he says, must make a commitment to the technology investment required. The other factor is less tangible.
“From what we’ve been told, flexibility between the two groups and the cultural fit are very important.”