IT Outsourcing Year in Review: Grading Our Predictions

Last year at this time, CIO.com and its outsourcing experts made some bold predictions for IT services in 2012. This would be the year all the cloud computing hype would finally blow over. Application development would migrate from offshore to second-tier cities stateside. And IT service providers would give sales-incentivized account managers the boot in favor of a more relationship-oriented approach.

None of those particular prognostications came to pass, of course. In reviewing last year's prophecies, one third of them were just wishful thinking. Almost half turned up in fits and starts. It seems 2012 was more about evolution than revolution in the IT outsourcing market. And a quarter of them were dead on.

As we pull together our 2013 forecast, here's how we rated those 2012 predictions:

Right On Target

2012 Will Be a Mixed Bag of M&A Activity

As predicted, there were no earth-shattering mega-deals in the IT services space. "Service providers gobbled up a few smaller service providers, but the valuations have driven them to acquire capability through better deal making with buyers," says Tony Filippone, executive vice president of research for outsourcing analyst firm HfS Research. HP's previous acquisitions of Autonomy and EDS made headlines throughout the year--for all the wrong reasons. "With HP's financial issues, one has to wonder if [CEO] Meg [Whitman] is going to sell," says Mark Ruckman, outsourcing consultant with Sanda Partners.

[ Related: More on Mergers & Acquisition ]

"By comparison, in 2012 IBM acquired at least eight mid-sized companies that provide various types of domain expertise that IBM likely will use throughout the enterprise-not just in the services division," says Bob Zahler, a partner in law firm Pillsbury's global sourcing group.

[ Related: IBM Closes $1.3B Kenexa Acquisition ]

IT Service Buyers Look Beyond Labor Arbitrage (But Vendors Don't)

Indeed, outsourcing customers began placing more of a premium on business outcomes than incremental cost savings while many service providers outcome-based contracting talk was simply that. "They too often fell back on replicating the same activities and service while using lower cost labor as the fundamental value proposition," says David Rutchik, partner with outsourcing consultancy Pace Harmon.

"However," adds Zahler, "this is not because they are misreading client objectives, but because for the most part outsourcing providers have not been able to deliver any meaningful process improvement and innovation."

Some outsourcers did begin offering more flexible terms, says Filippone of HfS Research. "And maybe this is all that buyers really wanted in the first place."

Global Companies Seek Global Support Beyond India

Dispersing the outsourcing portfolio among several geographies is now considered a best practice, whether to reduce geopolitical risk, access new skills or diversity operations. "India no longer is the low-cost location for certain types of services," says Zahler of Pillsbury. "Almost every presentation from a global outsourcing service provider begins with a slide or two identifying their numerous offshore facilities located around the world and the substantial telecommunications network they have developed tying all these delivery centers together in some 'seamless' fashion."

[ buzz around cloud computing? Hardly. "The hype about cloud computing has not abated; if anything, it has increased," says Pillsbury's Zahler. "Suppliers continue to make a good case that cloud computing does not increase security risks and that meaningful savings can be achieved." Adoption rates, however, may have been more sluggish than expected as the enterprise were slow to establish corporate policies and procedures related to cloud, regulatory questions about privacy and security continued, and big-name cloud providers suffered very public outages.

"Customers will likely continue to identify areas where cloud benefits outweigh cloud risks as economic uncertainty will magnify the cloud benefits," says Jason Krieser, partner with the law firm K&L Gates.

IT Offshore Providers Take Over Infrastructure Outsourcing

Some Indian IT service providers, like HCL and Wipro, are making great strides in the IT infrastructure space. "But it would be wrong to conclude that there has been a meaningful shift from U.S.-based infrastructure providers to offshore companies," says Pillsbury's Zahler.

IT Service Providers Account Managers Get the Boot

If only. "The annoyance is there but so, too, are the sales people," says KPMG's Lepeak. "Slow progress is being made with putting in better, more industry- and function-literate account management, but it is a slow process and one which still seems counter-intuitive so some providers and their leadership."

"The talent gap among the service provider community's account management teams has been a real sore point," says Filippone of HfS Research. "Our 2012 research shows that buyers have a desperate need for analytical thinking, better business-based solutions, and innovative thinking. This has taken the schmoozing order takers and tactically minded operations-based account managers by surprise. Service providers have just begun to learn that the size of a Rolodex is a poor metric of potential sales success."

Application Development Migrates Stateside

Any increase in domestic application development activity has been minimal, says KPMG's Lepeak. Outsourcing customers still sought cost savings first and foremost from their programming partners. "For many types of application development and maintenance work, it still is less expensive to do that work offshore than in secondary U.S. cities," says Zahler of Pillsbury. "Efforts are underway to develop truly cost-competitive development sites in the U.S., but such sites are not of sufficient scale to make a noticeable impact in the market."

Wait and See

Outsourcing Buyers Take it Slowly

That was true for big bang outsourcing deasl. "We continue to see a lot of 'wait and see' among buyers," says Stan Lepeak, KPMG's global research director. "A combination of weak economies, political uncertainty, fiscal cliff fear, and several years of living with incremental change as the norm has instilled a hesitancy among many buyers to pull the trigger on big change efforts, especially those with long term implications and big change management elements."

However, renegotiation of existing contracts-including selective addition of new services-was relatively strong, notes Zahler

IT Outsourcing Deals Gets Small

"Smaller deals ruled the roost in 2012, but look to the scheduled big deal renegotiations in 2013 and 2014 to demonstrate whether buyers want to break apart larger deals in favor of smaller once," says Filippone of HfS Research.

"The increasing importance of profit margin cannot be overstated," says Rutchik of Pace Harmon. "Chasing topline is a thing of the past&and the deals themselves in many instances are in fact smaller, or at least separated into more individual parts, with customers managing a multi-provider environment with internal tools, process and governance."

More Backsourcing Talk Than Action

GE stole the show with its announcement that it's working to hire 1,300 IT and engineering professionals at its Advanced Manufacturing and Software Technology Center (AMSTC) in Michigan by 2013. But any meaningful domestication of sourcing strategy will have to play out over years. "What we really saw in 2012 was organizations realizing that the onshore-offshore talent gaps were meaningful to some operations, but not everything," says Filippone of HfS Research. "Offshore volumes grew, but onshore capability became a differentiator in the eyes of buyers. Buyers began to tinker with how to successfully integrate offshore talent with onshore talent, which was a positive sign."

[ Related: Outsourcing Declines, Are IT Jobs Coming Back? ]

"Some work is coming back onshore and some work is not going offshore," adds KPMG's Lepeak. "But overall the relative size and value of this work remains small compared to the totality of what is outsourced."

IT Outsourcers Embrace Riskier Models

KPMG's Lepeak would call it "more a cool and detached hug than an embrace." Some providers, particularly those in Europe, did begin to shake things up. "We've seen providers say yes to deal structure points and people transfers that are atypical," says Krieser of K&L Gates, "likely because increased competition dictates that providers agree to these things in order to win deals." There were also more aggressive pricing tactics and service providers looking to leverage economies of scale," says Filippone.

But a wholesale embrace of new models? Didn't happen. " While there is a fair amount of talk about this, engagement models have not really changed much over the course of the past year," says Rutchik of Pace Harmon. "Providers will allocate 'innovation dollars' in order to win business, but these are effectively just that-business development tools rather than structural, strategic changes."

IT Security Takes Center Stage

Data breaches continued with hacker and state-sponsored threats looming large. But there was little link to outsourcing per se.

"Organizations are getting more disciplined in this area, but at a cost of higher operating costs and slower evaluation," says Filippone of HfS Research. "Privacy and security remain major issues within the buyer community."

Stephanie Overby is regular contributor to CIO.com's IT Outsourcing section.

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Read more about outsourcing in CIO's Outsourcing Drilldown.

This story, "IT Outsourcing Year in Review: Grading Our Predictions" was originally published by CIO .

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