In recent years, enterprises rarely approached IT outsourcing (ITO) as anything more than a commodity. Not any more. It's quickly heating up as a way to meet new challenges, and buyers are lining up.
Here's a run-down of recent trends that signal changes in ITO deals in coming months.
Business Transformation through IT Is Widening
Companies are moving beyond the defensive strategy of using outsourcing as a bottom-line activity and a means of cost containment. "We're seeing more and more companies looking to ITO as an offensive strategy for top-line growth," states Mark Fulgham, Vice President, IT Outsourcing, HP. "Potential clients come to us asking, 'How can you help us differentiate our company in the eyes of our customers and our industry?"
Joe Hogan, Vice President of Strategic Outsourcing Programs, Unisys, agrees. "Buyers are looking for IT service providers that can help change the buyer's environment to be more flexible and able to respond to change through better visibility into the linkages between business strategy and IT. They want assurance that in three to five years when it's time to renew the applications or infrastructure contract, they will be better off than they are today."
Chuck Pol, President, BT-Americas, also confirms the trend. "ITO is now more than cost-cutting. It's about driving innovation, enabling growth, and also fortifying operational excellence. Many contracts now have a technology refresh clause to keep clients at the leading-edge of technologies that will continue to drive innovation in their business."
Outsourcing to achieve innovation and business transformation changes the pre-contract-signing activities, starting with provider-selection criteria. These kinds of deals are not just "a distant approach that is managed to contract," says Fulgham. "The relationship in a transformational deal is more dynamic. There must also be value alignment, and the parties need to work much closer in a more intimate setting."
He says buyers want not only to understand a provider's current capabilities but also want to know its bench depth and, going forward how it can innovate and apply next-generation technology.
"Deals now take quite a long time to structure--18 months to two years," says Pol. "We're seeing an interesting trend in that the deals are for shorter lengths and have less value because they are not multi-tower deals, and now it takes longer to do the deal." This, of course, adds to the provider's costs.
"There's no question about it--the front end of the deal is elongating," agrees Fulgham. "Deals are taking three-to-six months longer today, and that trend is growing."
The front end is no longer a matter of just finding the right provider, negotiating price, and developing a stringent governance agreement. "Now the parties need to discuss how they are going to bring the appropriate innovation investment strategies on an ongoing basis into the deal," Fulgham explains. "That has not been part of the deal discussion till now. But innovation requires dual skin in the game. The provider has to come with a certain amount of innovation, and the buyer has to provide a certain amount of a test bed and the resources to allow for the innovation to come forward."
Another factor causing the front-end elongation is that the parties need to negotiate through intellectual capital issues. HP's engineering organizations, for example, are starting to work with clients' engineering organizations to assist them in developing their next-generation products and services. Fulgham says these customers are exploring the opportunities of co-licensing derivative works of intellectual capital.
Another trend is that high-end IT consulting, which is key to business-transformation deals, is experiencing an uptick. Fulgham notes that "the consulting hasn't been at this level of significance or this early in the timeframe before."
Innovation and transformation are not the only drivers for the IT consulting. He says a lot of it has to do with "issues surrounding the ability to create data-center pods in different localities so that they can move assets and computing infrastructure back and forth to support business-continuity and business-resumption issues." The issues focus on where to set up the pods in relation to power grids and also focus on application set-up.
Data center modernization is at the heart of infrastructure optimization in business-transformation deals because technology improvements are starting to collide with traditional (circa 1960s) data-center technology. As Fulgham remarks, we now have better ways of controlling cooling and energy consumption in our homes than in many data centers.
"For every dollar a company spends powering its assets, it now spends about $1.25-$1.50 to cool them," says Fulgham. "These are multi-year capitalized facilities assets, and companies need to take this into account in the total cost of ownership (TCO)."
Companies are now seeking a way to combat this TCO challenge and at the same time embrace new technology at a quicker adoption rate. Fulgham says buyers and providers are "speculating on a lot of different business models with dual skin in the game to figure out how to bring forward next-generation data centers and get them up and going quickly." He notes two models are starting to come into play more frequently.
The first is a transitional model, where the service provider builds the next-generation environment on the buyer's premises and then transitions it back to the buyer for the ongoing steady-state operations--all over an 18-36-month horizon. Fulgham says this model is attractive to large enterprises because they want their assets to remain on premise and, for many of them, having to turn over to a service provider the data contained in the assets is a sticking point.
Mid-market buyers are more interested in the second model, where the buyer moves its IT assets into the provider's controlled facility and the provider maintains them on an ongoing basis. In this model, the outsourcer provides not only the compute infrastructure but also the applications on top of that. It's a slight variance of the old ASP model.
"With either outsourcing model, buyers can get to the next-generation footprint in a fiscal-year 2007 timeframe," says Fulgham.
Quick implementation of next-generation technology is also the driver for a new model in the application space. According to Stu Gavurin, Vice President and Managing Partner, IT Outsourcing Service Line, Unisys, this model has recently become "a big wave and will become very common by the end of 2007."
Describing the need for the model, Gavurin says, "Companies have a lot of legacy applications still in a legacy mainframe or client-server environment with limited technology. These applications are not yet on the clever n-tier application architectures where there are all sorts of security and Web-based services."
Companies have been investing in systems-integration projects to modernize their applications, but that is changing. Gavurin describes the new play: "The buyer basically hands the application over to an outsourcer who, for purposes of continuous improvement in costs, gets the right to restructure the code in a more modern architecture that will help the provider better manage the application." The provider can continue to maintain the resultant modernized application, or the application can go back in house to the client.
This outsourcing strategy expands the application's life and also makes it deployable in a Service-Oriented Architecture (SOA). The model doesn't have a standardized name yet. Two terms for it at this juncture are "application outsourcing with modernization" and "transformational application outsourcing."
Network convergence (i.e., VoIP technologies) is driving another applications trend that will increase in popularity in 2007. Gavurin says companies now want to outsource the applications that will need to work in a converged environment.
In addition, he says the on-demand trend in outsourcing will grow significantly in 2007. At first it will be "mundane," focusing primarily on real-time computing capabilities for data-center outsourcing activities, but will become "robust, moving up to stacked applications in 2008."
The software and outsourcing headlines nearly every week for the past several months include continual announcements of mergers and acquisitions. On the acquisition front, Mike Jones, President of ITO, Infocrossing, says "A lot of the network providers are getting into the hosting business and moving into more of a managed-service offering." AT&T, for example, bought USinternetworking, the largest applications service provider in the US.
There are other examples. Gavurin at Unisys believes it's an indication that on-demand types of services are maturing and that application outsourcing is on the rise.
"There's a lot of companies interested in getting a piece of the action in managed services," comments Jones. "It's going to become a much more competitive environment. The Indian firms are trying to move into the space, as are the telecom carriers, hosting providers, and the existing big providers. We're going to see the effect of this in 2007 in that buyers will have more options. The demand is the same as it has been, but there are more players now to divide the pie."
Gavurin says one of the drivers is the need to "scale the smaller players' clever, unique infrastructure to the big players." Up to now, the consolidation activity has focused on larger services providers grabbing "the small fish, but is now starting to move up to the medium fish."
On the merger front, Gavurin notes that the days of outsourcers being vendor-agnostic are going away. "We're starting to see tighter alignment of outsourcers with software providers than we've seen before."
Many software vendors are recognizing that the enterprise buy of their products is shrinking as companies move to the outsourcing model. And the outsourcers want to play in a different space, providing certain vendors' applications for clients. Those are the two drivers for the outsourcer/software vendor marriages. Gavurin predicts a lot of joint solutions--enabling soup-to-nuts services--will enter the market in 2007.
Whether it's a merger, acquisition, or a joint marketing solution, Gavurin says the attraction to the services providers is "buying differentiating intellectual property as executed. Research and development costs are such that it's better just to buy intellectual property than to develop it yourself. We're going to be seeing a lot of this in the apps space and in the virtualization space next year."
Virtualization--in several senses--is the next frontier in IT outsourcing. Gavurin says there is currently a big push for real-time capabilities with VMware and other virtualization technologies. "This is the final step in best practices in resource management," he states.
In a traditional business model, people all around the world working on the same client problem or product would need to fly to a location where they can physically have meetings. In contrast, collaboration technology that enables people in several countries to have real-time meetings in a virtual conference room would be a powerful leverage for innovation.
Hogan at Unisys relates an example of where this type of strategy leverages intellectual capital around the world in product development. There are movie companies today that have built their own networks where they have access to television video capability for developing animation. They do the drawings in China, the engineering in the UK, and the marketing in the US.
Hogan suggests that the model is transferable. "Buyers and providers in an outsourcing relationship should be able to meet virtually in video rooms to discuss outsourced applications, technology problems, or product development in real time and in a secure environment," he says. "Today, such video links are herky-jerky, there is not enough bandwidth, there are delays, and it's very frustrating. "
Hogan predicts that outsourcing providers will develop the technology and incorporate such solutions as part of their outsourcing relationships and that this should happen in the next two or three years.
Mobility Trend Resurfacing
Workforce mobility is another driver for growth in IT outsourcing. This was a hot button a couple of years ago for mobile applications, but it died down. However, the concept of "if you build it, they will come" is still realistic. Gavurin of Unisys says the increasing number of US cities and vendors investing in WiMAX (Worldwide Interoperability for Microwave Access, enabling access without an 802.11LAN) has resulted in increased corporate use of mobile devices. These companies are now looking into outsourcing their device management.
For companies that want to operate at their fullest potential, the ability to distill their raw data into information that can be used in a timely manner is crucial. "Most companies are rich in quantities of data but poor in usable information," says Bret Allinson, Senior Vice President, Global Delivery, HP Services. He notes a trend of companies "beginning to explore more consolidated data management strategies similar to what Wal-Mart has done."
In last year's forecasts issue of Outsourcing Journal, we discussed the predicted change to the multisourcing model in 2006. Tony Viola, Vice President, Marketing at Patni Computer Systems, says it's now a "clear trend." At Patni's annual customer conference in September, clients identified multisourcing among their buying behaviors, and Viola says it has not been on the radar screen before.
Fulgham at HP brings up two important developments in multisourcing. "First, we're seeing a very solid process acumen starting to emerge." The industry is experiencing a reorientation from a technology-people-process approach to synchronizing first around process. "Process is becoming the language and frame of reference that everyone needs to live by in a multisourcing environment," he says.
Second, he mentions a critical event of 2006--General Motors moving to what it refers to as a third-generation outsourcing model. "GM is trying to get all the providers in a buyer's environment to have accountability among each other." This requires a more intricate accountability stream and critical-path analysis. It also requires more robust program management to ensure accountability in the inputs and information that the providers and buyer pass among themselves. "Going forward, we'll be seeing some blending on contracts," Fulgham predicts.
Asset management is now a critical business process because of compliance with the Sarbanes-Oxley Act of 2002 and other regulations, but the cost barrier to entry for managing this process effectively is too high except for mega-corporations. So, more companies are starting to outsource it.
As Gavurin at Unisys points out, "It takes a lot of money to build an infrastructure and buy the management tools for asset management, and companies can't afford to invest in IT that isn't going to promote revenue growth." He adds that most companies also don't have the expertise in house to conduct such activities as knowing when and how to discover the assets, or how to allocate and categorize them.
Many companies are now starting to retain the top-line business aspects of asset management in house for the IT staff and outsourcing the other aspects that are costly.
As with any business process experiencing an increase in outsourcing, look for service providers to bring new solutions and efficiencies to bear in asset management, which will strengthen the value proposition for outsourcing the process. Unisys, for example, believes that deploying for its clients PCs that use Intel's new vProTM technology could have significant potential for reducing costs in asset management. The vPro platform runs an application on hardware, enabling such activities as managing and discovering the asset, tracking who uses the machine, changing its configuration, delivering software to it, and other asset-management functions.
In addition to Intel, Gavurin notes that Lenovo is putting software in machines so they are more discoverable and can be inventoried more efficiently. "This is a real trend, although at a very base level," he says.
Hogan at Unisys paints a picture of ITO for the next few years. He cites a Microsoft sales video around convergence technologies as an example. "In the video, there is a senior exec in a corporation with a plasma screen in front of him. The technology enables him to pull all the sales information on a product line, change the pricing, get the communication out to the sales force, get the information over to the distribution arm and also to the marketing folks in New York to drive the campaign. And it all happens in less than half a day."
He predicts that people now coming into the workforce will demand that kind of technological support to run their businesses just four or five years from now.
"Companies not operating with the latest in technologies will find it difficult to attract workers in the very near future," says Hogan. "Executives need to be thinking now about a sourcing strategy that will quickly and cost-effectively provide that kind of environment."
Lessons from Outsourcing Journal:
- Companies are turning to IT outsourcing as a top-line-growth enabler rather than outsourcing for cost-containment.
- Outsourcing to achieve innovation and business transformation changes the pre-contract-signing activities. Consequently, the front end of deals is taking 18 months to two years.
- Up-front activities in a transformational deal need to include a discussion on how the parties will bring the appropriate innovation investment strategies into the deal on an ongoing basis.
- The cost of controlling cooling and energy consumption in data centers must now be taken into account in the total cost of ownership.
- To meet buyers' need to bring forward next-generation data centers and get them up and going quickly, a new transformation model is emerging for infrastructure outsourcing, where the service provider builds the next-generation environment on the buyer's premises and then transitions it back to the buyer for the ongoing steady-state operations.
- "Application outsourcing with modernization" is another new ITO model. The buyer hands the application over to an outsourcer who restructures the code in a more modern architecture that will help the provider manage it better. The provider can continue to maintain the resultant modernized application, or the application can go back in house to the client. This expands the application's life and makes it deployable in a service-oriented architecture.
- The days of outsourcers being vendor-agnostic are going away. We're starting to see tighter alignment of outsourcers with software providers, either in mergers and acquisitions or in joint go-to-market solutions.
- In the next two to three years, technology will likely be developed enabling buyers and providers to meet virtually in video rooms to discuss outsourced applications or technology problems in real time and in a secure environment.
- Asset management is now a critical business process because of compliance with Sarbanes-Oxley and other regulations, but the cost barrier to entry for this process is very high. More companies are starting to outsource asset management, retaining the top-line business aspects in house and outsourcing the aspects that are costly. Providers are starting to develop cost-reduction tactics and create even greater value propositions for outsourcing this process.