The EquaTerra Echo: 1Q10 Edition
About The EquaTerra Echo
EquaTerra introduced in 2010 a new quarterly research deliverable, the Echo. The first edition of the Echo was released January 29, 2010. Through the Echo, EquaTerra delivers quarterly a wrap-up and analysis of events and trends in the global business and information technology (IT) services markets. The Echo complements and extends the EquaTerra quarterly global Pulse surveys. The Echo draws from findings from EquaTerra’s own research and client engagements as well as newly released research and commentary from select consultancies, research firms, equity analysts and news agencies.
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Market Overview
The demand for business process and IT outsourcing (BPO/ITO) continued to grow in 1Q10, though at a slower pace than in recent quarters according EquaTerra advisors and third-party service providers polled as part of EquaTerra’s global quarterly Pulse survey and according to others that track business and IT services market trends and developments.
There has been a resurgence in outsourcing deal flow disruption driven by negative economic conditions in western markets. This is manifested by more cautious buyers that are very hesitant to make any major upfront outlays to support outsourcing efforts or enter into larger, more complex and uncertain deal arrangements. This “double dip” is creating market conditions similar to those witnessed in late 2008 and will likely continue for at least the next one to two quarters. Current outsourcing market deal flow is characterized as follows:
- Deal flow disturbance in service provider pipelines
- Projects deferred
- Projects starting smaller
- Gates within projects taking longer to clear and with more down time between them
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Buyers are still aggressive about reducing and keeping down operating costs and continue to work to overhaul service delivery models, trends that are positive for long- term outsourcing growth. Buyer interest in alternatives to BPO and ITO grew in the quarter. Buyers today are more often employing a broader range of change initiatives such internal process improvement efforts, shared services centers and software as a service (SaaS) as a complementary or alternative means to outsourcing. More rapid and continual change, and even more diligent focus on process efficiency, is another aspect of the “new normal.” Buyers are employing a greater diversity of tools in response.
Key News and Events
- EquaTerra Pulse Surveys (www.equaterra.com)
- Business and IT services market demand -- Advisors: 46% cite growth in demand Q/Q; Service providers: 71% cite pipeline growth Q/Q; 57% expect demand to grow next quarter
- Economy’s impact on outsourcing -- Advisors: 45% indicate the economy is driving more outsourcing, 36% say conditions are slowing deal flow; Service providers: 46% indicate the economic climate is driving more outsourcing, 43% say buyers are slowing/rethinking outsourcing
- Gartner Group (www.gartner.com)
- “Worldwide IT spending is forecast to reach $3.4 trillion in 2010, a 5.3 percent increase from IT spending of $3.2 trillion in 2009, according to Gartner, Inc. The IT industry will continue to show steady growth with IT spending in 2011 projected to surpass $3.5 trillion, a 4.2 percent increase from 2010.”
- “The worldwide IT services industry is forecast to have spending reach $821 billion in 2010, up 5.7 percent from 2009. The industry experienced some growth in reported outsourcing revenue at the close of 2009, an encouraging sign for service providers, which Gartner analysts believe will spread to consulting and system integration in 2010.” [Source: Gartner Newsroom. Gartner Says Worldwide IT Spending to Grow 5.3 Percent in 2010. April 12, 2010. http://www.gartner.com/it/page.jsp?id=1339013.]
- “Key indicators from both the demand-side and supply-side signal a recovery for the IT services market in 2010, which was negatively impacted in 2009 due to the economic crisis and the widespread impact globally. Specifically for ITO, Gartner is predicting a return to growth, with a 6.6% growth (U.S. dollars) in 2010 (3.4% growth in constant currency).” [Source: Forecast Analysis: IT Outsourcing Services, Worldwide, 2009-2013, 1Q10 Update, Publication Date: 24 March 2010 ID Number: G00175146]
- TPI Index (www.tpi.net)
- “The 1Q10 Global TPI Index, which measures commercial outsourcing contracts valued at $25 million or more, recorded total contract value (TCV) of $19.5 billion, up 25 percent from the first quarter of 2009.”
- “Contract restructurings accounted for 42 percent of TCV, far surpassing the previous record of 29 percent set in 2006.”
- “In all, 109 contracts were awarded in the quarter, down 21% year-over-year, and there were fewer awards valued at greater than $200 million. This represents a break in the pattern of a greater number of smaller contracts seen over the last four or five years.” [Source: News@TPI. Large Contract Restructurings Lifted Outsourcing Marketing in First Quarter. April 21, 2010. http://tpi.net/newsevents/news/releases/100421-US.html.]
- Veracode (www.veracode.com)
- Veracode, provider of “the world’s leading Application Risk Management Platform” and an EquaTerra business partner, released the first installment of its State of Software Security report based on “intelligence gleaned from analyzing billions of lines of code submitted to Veracode for independent verification of software security from more than 15 industries.”
- Among the findings presented in this report were the following.
- 57% of all software applications developed by third party outsourcing service providers were deemed to have “unacceptable” security quality according to the Veracode testing program.
- This compares to 58% of applications deemed unacceptable overall, 71% of commercial and 59% of open source applications
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Analyst Insight
Commentary from Phil Fersht, Founder & CEO, Horses for Sources, blogger extraordinaire and one of the top market research analysts covering the business and IT services marketplace. Click on a title to read each article here on equaterra.com:
The New Relentless Economy Drives Unprecedented Interest in Global Outsourcing Endeavors
As the recession slowly lifts, many businesses, secure in the knowledge that their financial performance is on safer ground, start to act on their more transformative planning to increase productivity and source new avenues for revenue. This is exactly the state of play for most industries in 2010, with an unprecedented number of new firms moving into outsourcing engagements, with the objective of driving down operational cost, but also to globalize processes and force change into jaded business models of yesteryear. Click here to read the full article.
Healthcare Payors Reshuffle Their Priorities in Light of Healthcare Reform and Will Look to BPO
Healthcare reform will absolutely transform the healthcare payor industry. Mandated medical loss ratios, state-run insurance exchanges, guaranteed coverage, and required purchase requirements will restructure the payor’s business models. The trickle-down impact on operations will be significant, shifting priorities in a manner that will eventually impact outsourcing priorities. Click here to read the full article.
An interview with Karl Keirstead, Lead Analyst, IT Services & Enterprise Software, Kaufman Brothers Equity Research, and one of the top U.S.-based equity analysts covering the business and IT services markets.
EquaTerra: Karl, given that the economies of the US and most Western European countries have been improving over the past quarter, this would seem to be a positive indicator for business and IT service providers. From your perspective as an equity analyst, what are you seeing in the market in terms of overall supplier performance and momentum?
Keirstead: “I’m sensing that most technology vendor CEO’s have been surprised by the V-shaped economic recovery and it is clearly lifting demand for virtually every technology segment. There are two key issues that investors are debating. First, what portion of the current up-tick is due to temporary pent-up demand from projects frozen in 2009 and how much is sustainable well into the second half of 2010? Second, investors recognize that the slope of the recovery in IT spend varies by segment, and everyone is trying to determine which segments (consumer PCs, enterprise PCs, servers, network equipment, license-based ERP and middleware, hosted or cloud-based software, consulting, IT outsourcing) are likely to outperform in the second half of 2010.
Narrowing the discussion down to the outsourcing space, the Street has so far been disappointed in the pace of the recovery. Bookings are improving but not at a pace some were expecting given that this is a cost-based offering and revenue growth remains sluggish and negative given the weight of the re-pricing and re-scoping that vendors were forced to absorb throughout 2009. The only group of vendors that is prospering are the India-based firms. The Street has now largely re-set their growth expectations for the IT outsourcing market in the 0-5% range for 2010, a sluggish growth profile that is limiting the upside and P/E multiples for stocks like IBM, HP and Accenture, all of which have under-performed the overall equity market indices so far in 2010.”
EquaTerra: EquaTerra's 1Q10 Pulse survey noted resurgence in outsourcing deal flow disruption. Inherent buyer demand is there and business is entering sales pipelines but it's slow to come out as sold deals. Buyers are again being cautious about making any major upfront investments or undertaking any perceived high risk outsourcing efforts. How does this tally with what you're seeing in the market?
Keirstead: “It squares perfectly with the reported numbers coming out of the vendors (i.e. weak revenue growth and improving but sluggish bookings growth) but it does NOT square (as one might expect) with the current tone from the vendors, all of whom are saying that the pipeline of pending deals is up smartly and that this should translate to bookings in 2H10. Vendors are always bullish about the pipeline and the conversion to revenue growth is seemingly always ‘just two quarters away,’ so skeptical investors are digging into the issue of why the pipeline is not converting and if/when it might. Based on our checks with CIOs and with other sources, we remain skeptical. It seems that there is far more interest in using the India-based model, deal sizes are getting reduced, large multi-scope deals seem rare and it seems that the value proposition must not be sound if so many clients are electing to go through a consolidation of data centers and back-office operations internally rather than using third-party vendors.”
EquaTerra: What are you hearing from business and IT service providers relative to their investment and hiring plans? We're hearing about more hiring, some concerns over wage inflation and skills shortages, etc., but it may be premature to say the industry is back on the fast track of a few years ago. What do you think?
Keirstead: “We too are hearing that most outsourcing firms are starting to kick-start their hiring efforts and most are acknowledging that wage inflation is up-ticking. However, most of the hiring activity is being done offshore, illustrative of the price and margin compression that the vendors are facing and reacting to. For instance, Accenture is hiring 50,000 new employees in fiscal 2010 but just 7,000 are being hired in the United States. Likewise, IBM just announced a $560 million charge related to ‘workforce rebalancing’, whereby IBM services headcount is being reduced in Europe and shifted to cheaper offshore locations.”
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Select Earnings and News
- Accenture (ACN): released 2Q10 earnings on March 25, 2010. 2Q10 net revenues were $5.2B, a decrease of 2% in U.S. dollars Y/Y and diluted earnings per share were $0.60. New bookings for the quarter were $6.5B, with consulting bookings of $3.4B and outsourcing bookings of $3.1B, bringing total new bookings for the 1H10 to over $12B. Analysts did not cite the demise of the Tiger Wood’s sponsorship as having a material impact on earnings.
- Capgemini (trades in Europe):: released FY09 earnings on February 18, 2010. FY09 revenue for the FY09 was €8.4B, down 4% Y/Y on 2008 published revenues and profits were €178M, down 60% Y/Y. Total bookings for the year were €9.3B, down 2% Y/Y, although outsourcing services booking were up 14%. Capgemini noted the strength of outsourcing stating, “The consulting and IT services market, which had demonstrated remarkable resistance in 2008, slowed considerably in 2009. In this context, Capgemini successfully contained the decrease in revenues thanks to the stability of its outsourcing business, which often represents a solution particularly well adapted to the new concerns of clients and also its recently strengthened presence in the public sector as well as the energy and utilities sector, where demand remained stronger.”
- Cognizant (CTSH): released 4Q09 and FY09 earnings on February 9, 2010. FY10 revenue increased to $3.279B, up 16% from the previous year. Diluted EPS on a GAAP basis was $1.78, compared to $1.44 in the previous year. The firm projects FY10 revenue to be at least $3.935B, up at least 20% compared to 2009. Francisco D ‘Souza, President and CEO of Cognizant said, "During the year, we grew our workforce by more than 16,700 people, improved our employee utilization, strengthened our client partnerships, and brought new services and capabilities to market.”
- Convergys (CVG): announced March 4, 2010 that it is selling its Human Resources Management (HRM) line of business to NorthgateArinso for approximately $85M in cash at closing and $15M in cash over three years, signaling its exit from the multi-process HRO market. See related EquaTerra commentary on this move.
- CSC (CSC): released 3Q10 earnings on February 10, 2010. Revenue was $4.0B and fully diluted earnings per share (EPS) of $1.36 compared to third quarter fiscal 2009 revenue of $4.0B and EPS of $1.06, a 28% EPS increase over last year. New business awards of $6.8B for the quarter and $14.9B through three quarters, an increase of 17% over the previous year. CSC Chairman and Chief Executive Officer Michael Laphen said, "I was particularly pleased with our new business awards of $6.8B, significantly above last quarter and last year. On a year-to-date basis, we are $2.2B ahead of last year and well positioned to meet our guidance expectations of $17-$18B in new business awards."
- HCL Technologies (trades in India): released 3Q10 earnings on April 21, 2010. Revenue was $685M, up 5% Q/Q and 21% Y/Y. EBIT was $111M, up 20% Y/Y and net income was $77M, up 78% Y/Y.
- HP (HPQ): released 1Q10 earnings on February 17, 2010. Services revenue decreased 1% to $8.7B. Infrastructure Technology Outsourcing revenue increased 2% to $3.9B. Technology Services revenue decreased 2% to $2.4B. Application Services posted revenue of $1.5B and Business Process Outsourcing posted revenue of $734M down 8% and 3%, respectively. Operating profit was $1.4B, or 15.8% of revenue, up from $1.1B, or 12.9% of revenue, in the prior-year period. Overall HPQ net revenue was $31.2B, up 8% from a year earlier and up 5% when adjusted for the effects of currency, GAAP diluted earnings per share (EPS) was $0.96, up from $0.75 in the prior-year period.
- IBM (IBM): released 1Q10 earnings on April 19, 2010. Total Global Services revenues increased 4 percent (down 2 percent, adjusting for currency). Global Technology Services segment revenues increased 6 percent (flat, adjusting for currency) to $9.3B. Global Business Services segment revenues were flat (down 5 percent, adjusting for currency) at $4.4B. IBM signed services contracts totaling $12.3B, at actual rates, a decrease of 2 percent (7 percent, adjusting for currency), including 13 contracts greater than $100M. Application Management signings decreased 23 percent, or approximately $700M. Without the impact of this decline, total services signings would have been up 4 percent year to year. Overall 1Q net income was $2.6B compared with $2.3B in the first quarter of 2009, an increase of 13 percent. Total revenues for the first quarter of 2010 of $22.9B increased 5 percent (flat, adjusting for currency) from the first quarter of 2009.
- Infosys (INFY): released 4Q10 and FY10 earnings on April 13, 2010. FY10 revenue was $4.8B, up 3% Y/Y and 4Q10 revenue was $1.3B up 5% Q/Q. Net income for FY10 was $1.3B, up 9% Y/Y and $349 for 4Q10, up 4.5% Y/Y.
- Tata Consultancy Services (BSE:TCS): released 4Q10 and FY10 earnings on April 19, 2010. FY10 revenue was $6.34B, up 5% Y/Y, FY net profit was $1.45B, up 29% Y/Y, FY10 EPS was $.74, services business volume grew 17%.
- Wipro (WIT): released 4Q10 and FY10 earnings on April 23, 2010. FY10 IT services revenues were $4.4B up 2% Y/Y and 4Q10 IT services revenue was $1.2B, a sequential increase of 11.5% Y/Y. IT Services Earnings Before Interest and Tax (EBIT) was Rs. 47B ($1.05B) up 18% Y/Y and 4Q10 EBIT was Rs. 12.7B ($283M), up 20% Y/Y. WIT IT Services added 121 new clients in the year. Azim Premji Chairman of Wipro, commenting on the results said, “We have seen another strong quarter of broad based, volume led growth. We saw good recovery in our challenged verticals of Technology and Telecom. The business environment is returning to normal. For the quarter ending June 30, 2010, we expect revenues from our IT Services business to be in the range of $1,190 million to $1,215 million.”
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Five News Articles Worth Reading
The Last Word and a Look Forward
While deal flow for third-party business and IT outsourcing services slowed in 1Q10, EquaTerra remains bullish on longer-term demand. If buyers remain more cautious, thorough and in some cases more conservative in their outsourcing efforts this will be a good thing. Often the problems buyers have experienced with outsourcing efforts have been caused by their own haste. This is manifested in unrealistic business cases, vague outsourcing goals (like transformation and innovation) detached from the realities of the efforts contracted, and poorly skilled, underfunded and under staffed transition and sourcing governance efforts. Buyers are well served to ensure that their outsourcing ambitions realistically map to their capabilities to source, deliver and manage efforts. Buyers are advised to take an integrated portfolio approach to change and cost management. Utilizing BPO and ITO may serve as the foundation for these efforts, but they must also leverage other change agents like internal process improvement, the deployment an expansion of shared services centers, and increasingly the use of cloud computing and Software as a Service.
Original content © Copyright 2010 EquaTerra, Inc. All rights reserved. Citations of third party content in this publication are copyrighted by their respective owners. Reproduction or distribution of this publication by any means, in whole or in part, is prohibited without prior written permission from EquaTerra, Inc. and, in the case of third party content, the copyright owner. EquaTerra does not endorse any company, product, or service or warrant the accuracy, timeliness or appropriateness of any information or advice described in this publication. Opinions reflect the author’s judgment at the time of publication and are subject to change. The information contained in this publication is provided for informational purposes only, should not be construed as legal, accounting, tax, career or other professional advice of any kind, on any subject matter, and should not be relied upon or used as a substitute for consultation with professional advisors.
Input for and Feedback on the Echo
Have an idea on a topic to cover or key event to report? Let us know! Please direct all comments, questions, ideas and feedback on the EquaTerra Echo to
Stan Lepeak
Managing Director, EquaTerra Global Research
+1 203 458 0677
stan.lepeak@equaterra.com. Learn more from EquaTerra
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About EquaTerra
EquaTerra sourcing advisors help clients achieve sustainable value in their IT and business processes. Our advisors average more than 20 years of industry experience and have supported more than 2,000 transformation and outsourcing projects across more than 60 countries. Supporting clients throughout the Americas, Europe, Middle East, Africa and Asia Pacific, we have deep functional knowledge in Finance and Accounting, HR, IT, Procurement, Real Estate and Facilities Management and other critical business processes. EquaTerra helps clients achieve significant cost savings and process improvement with internal transformation, shared services and outsourcing solutions. For more information, please contact Lee Ann Moore at +1 713 669 9292; www.equaterra.com.
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