Client Restructuring Rather than Buying Caused Recent BPO Decline

According to the 2010 fourth quarter TPI Index released recently, the global sourcing industry is sending us some pretty mixed signals. A sluggish economy, smaller contract values, and firms trying to optimize technologies like cloud all make the services marketplace quite unpredictable.

But there are some key trends that emerged, and we asked Mark Mayo, Partner and President at TPI, to help us decipher the numbers. He explains why buyers are renegotiating contracts rather than signing new ones, why BPO activity is down across the board, and what this all means for Latin America.

What were the main TPI findings and what do they tell us about the state of global outsourcing?

Mayo: We always look at both the quarter numbers as well as the year over year numbers. From the third to the fourth quarter of 2010, it’s true that the industry was up 30%, but that’s not saying much since that third quarter was pretty weak. More relevant would be to compare 2010’s fourth quarter with 2009’s fourth quarter. We had a huge Q4 2009 driven by a number of restructuring and renegotiation activities, and Total Contract Value (TCV) from then to Q4 2010 was actually down 30%.

When we peel back the layers, we see that this was caused by a large fall in BPO activity. ITO was also down about 4% and came in at $62.4 billion, but BPO was down 31% and came in at a TCV of $17 billion. We had 14 mega deals in 2010, and every one of them was ITO.  There were no large BPO opportunities; not a single one with a contract value greater than a billion dollars a year, which is atypical. We usually have three or four of them, but it just didn’t happen last year.

Is that solely due to the after effects of the recession, or are there other causes for the downward BPO trend?

Mayo: It is somewhat due to the recession. For big BPO opportunities you typically have to put in major investment to get them up and running, and people were slow to make those investment decisions last year. Instead they were going for smaller BPO opportunities that were mainly labor driven, and sold on time and materials (T&M) contracts. Buyers were wary of large opportunities, and were tending to buy in single process, bite size chunks that don’t involve much risk.

Another reason for the drop in BPO is that we’re seeing a lot of restructuring of contracts to be more cost effective, but very few new contracts. Part of that is just a cyclical effect, since around now is when many contracts are up for renegotiation – and that will continue into 2011. But another reason is that service providers are offering better pricing than before, so it’s in buyers’ best interest to re-evaluate their existing contracts than invest in new deals. The trend of multisourcing is another factor, where clients work with many different vendors depending on the scope and function of the outsourced project. That results in each contract being smaller in value.

The pipeline for new contracts and new deals as we go into 2011 just doesn’t look very strong from an industry perspective. I think we will have a few mega-deals this year, but we’re definitely being cautious in the first quarter.

IT sourcing Total Contract Value was also down. To what extent that is that due to the cloud offering that everyone’s going after?

Mayo: Yes ITO was down 4% in 2010 compared to 2009, but that hasn’t been due to cloud taking away market share from traditional IT vendors. Cloud is getting a great deal of press, and service providers are all repositioning either their offerings or their marketing strategies to go after it. Much of it is hype. What we’re seeing is an awful lot of discussion and planning on cloud, but in terms of real contracting activity for major corporations, there really wasn’t much in 2010. Most of the activity happened in smaller sized opportunities in the mid-market. That’s actually the sweet spot for cloud right now, and will continue to be for some time.

So no, I don’t think it’s had a big impact at all on the ITO numbers that we reported.

What were your findings specifically for the Latin American or Nearshore IT and BPO industries?

Mayo: The index focuses on buying activity, and there has definitely been a pickup over the last five years. If you look at the activity back in 2005, Latin America was awarded about 15 contracts a year. That increased steadily each year to 49 contracts in 2010, which means it more than tripled.

Of course that strong performance was heavily driven by Brazil, both on number of contracts and TCV. The country has a total of 136 contracts, with Mexico following at 48 contracts. So there’s clearly a big tendency towards those two markets in terms of where work is being awarded. In 2009 Latin America was at $2.3 billion, and the lion’s share of that was Brazil at $1.8 billion. It was substantially up from the run rate we were seeing in 2007 and 2008.

It’s important to note that everything that we’re seeing in that space is pretty much ITO. The BPO opportunities in Latin America are very little; mainly call centers or mid-office insurance and banking opportunities. The traditional horizontal plays that we’ve seen in the US just haven’t hit Latin America. Much of the high value work in Latin America is heavily focused on IT infrastructure and applications. And the major service providers in the Latin American space are still really IBM and HP.