Outsourcing Industry Mergers Spell Bad News for IT

CIO - IT services industry watchers say the question is not if, but when the next big merger between outsourcing vendors will happen.

"There will be more consolidation in the ITO industry, and it will occur at every level," says Mark Robinson, chief operating officer for outsourcing consultancy EquaTerra. That's good news for some providers and for the industry, but the outlook for customers is cloudy.

"Overall, consolidation tends to concentrate quality and spark innovation," Robinson says. "However, these benefits to the industry come at a price, and that price includes a reduction in competition and an increased--albeit transient--risk of service quality disruption. The next 24 months will be a period of relative instability in the industry, and you should expect to see other big names make their moves."

[ Five Steps to Take if Your Outsourcing Provider Is Sold ]

Consequently, customers with large infrastructure outsourcing deals may be nervous, says Charles Arnold, managing director of EquaTerra's information technology practice. "Most companies employed a single-provider strategy. Companies who chose HP very likely also considered EDS and opted to go the other way for whatever reason," Arnold explains. "It can be a bitter pill to swallow when your chosen provider changes its stripes."

Those customers who are shopping around for infrastructure providers may notice a change in their options. "There are now fewer top players to choose from," Arnold says, "which can limit competition or push buyers into the second tier of providers [who] may not have been invited to the table before."

Further consolidation on the infrastructure front could also erode customer power at the bargaining table. Arnold notes that in the early days of IT outsourcing, customers didn't have much leverage when it came to contract negotiation because there were so few providers (and thus, so little competition among them.) But as the number of providers increased, so too did customers' power over contract negotiations, and customers came to expect "reasonable flexibility on everything from price to service delivery model," says Arnold. "This has made for a fairer and more competitive marketplace, albeit one with thinner margins than the old days for the providers."

For that scenario to remain the case, the industry needs at least three to four large providers in competition for contracts, according to Arnold. "If the number of credible contenders for very large deals shrinks too far, the balance will shift again, and buyers may find themselves back in a relatively powerless position." That is not yet the case.

Questions About Service Quality

Another concern for new and existing customers is transition--both their own and their providers'. "Transition and ongoing operations for an enterprise customer are very large and very complex endeavors," says Arnold. "The concern is that during this very challenging time for an enterprise buyer, the provider is also undergoing a transformation, one associated with their own integration activities."