In today's economy, IT service providers are faced with declining market revenue and an acute need to protect their margins, so organisations need to understand the changing behaviour of IT service providers and the measures they take to avoid unforeseen business and operation risks.
According to Gartner, organisations also need to ensure that their providers remain the right fit for them.
"2009 and 2010 will be a critical period for the outsourcing and IT services market," says Claudio Da Rold, vice-president and distinguished analyst at Gartner. "Organisations are concentrating on IT cost reduction and aiming to improve their business performance and flexibility. We predicted in the first quarter of 2009 that the global IT services market will decline 1,7% in 2009, and we are reviewing this forecast with an even more cautionary orientation."
IT service providers are facing some challenges that include the rise of renegotiation of multiyear and outsourcing contracts, the development of alternative delivery models, and the need to balance price reductions.
Gartner predicts price erosion in infrastructure outsourcing from 5% to 20% through 2010. For application services, there has been a broad set of price reductions, from the single-digits in India to the high of 10% to 20% in China, and intermediate levels in Europe and the US.
Gartner expects that spending in these areas will contract the consulting and integration market by 3% to 5% during 2009.
"Although these potential price reductions are a positive indicator for end-user organisations, they hide a major risk for the market as a whole. As price reductions of more than 10% would be higher than the net profit of most IT service providers, they could potentially make them bankrupt," adds Da Rold.
To thrive in a recession, IT services providers must not only reduce their own costs and protect their margins, but also achieve greater flexibility to respond to the unavoidable market fluctuations. In addition, to harness the industrial IT service evolution, IT service providers must invest in the development of alternative delivery models and new industrialised offerings.
As a result of these various challenges, end-user organisations should expect very different behaviour from their providers, depending on the health of the provider's business, the availability of cash and financing, and the provider's strategic outlook.
"Struggling providers will concentrate on protecting their existing business, and reducing cost, as the only approach to margin protection. The duration of the downturn will dictate their future. More-traditional providers will favour their capability-based business models, and will eventually accept a degree of revenue reduction (coupled with cost reduction) to maintain limited margin erosion, instead of embracing the high-risk transition of business models," says Da Rold.
Furthermore, savvy providers will reduce the costs associated with the delivery of traditional services by a contemporary use of staff/cost reduction and standardisation/automation, and will create greater flexibility by using non-traditional approaches like spin-offs and partnerships. Finally, future leaders will accelerate investments to the extent that the market increases its acceptance and interest in new, industrialised services and value-based solutions.
To increase the alignment with IT service providers during the downturn, Gartner recommends that end-user organisations develop a strategic vendor relationship programme and advices that they include the following due diligence activities:
* Every six months (at least) – examine evidence of their strategic/major provider's investment profile, and the announcement/availability of industrialised offerings.
* Every six months – re-evaluate the health of their major providers, and refresh their risk analysis.
* Every 12 months (at least) – re-evaluate their sourcing strategy to align to business requirement changes and account for markets, providers and new offering developments.
"For strategic relationships, especially in hard times, there is only one viable balance: win-win. If one side loses, the other loses, too," says Da Rold.