ITO Multisourcing Taking Off but BPO Bundled Deals Remain More Common

In recent months there has been much talk of an increase in multisourcing, whereby buyers split deals between multiple vendors instead of bundling them together into one larger …

"The biggest driver of multisourcing is the generation of this new technology that companies want to be able to take advantage of," says Jimit Arora of Everest Group.

In recent months there has been much talk of an increase in multisourcing, whereby buyers split deals between multiple vendors instead of bundling them together into one larger contract with a single service provider.

This strategy enables buyers to handpick best-of-breed solutions while retaining greater flexibility and reducing dependency on any single vendor. However, this trend is much less pronounced in BPO than it is in ITO and some analysts believe it is part of a cyclic pattern rather than a significant shift in the way of doing business. Moreover, multisourcing has not yet taken off in Latin America to the same extent that it has in more mature markets.

What’s Happening?

A BPO and ITO market trends and insights report released by Information Services Group late last year suggests that instead of just searching for the lowest market prices, experienced buyers are increasingly eschewing the large, bundled service contracts of the past in favor of several shorter, sharper engagements with more specialist service providers.

ISG noted that while cost savings are still the primary driver behind outsourcing, clients are increasingly turning to service providers to help them become more innovative and agile. While smaller providers may not be able to meet all their needs, they are more willing than ever before to work with them on the basis that they can deliver exceptional performance in a specific process area. This is leading to a rise in industry-specific BPO and an increase in ITO multisourcing in application development and maintenance, data centers, end-user computing and managed network service, ISG stated.

“We’ve been seeing this for the last two years and it’s becoming increasingly common in the marketplace. It started off on the infrastructure side and that’s where we see the most instances of it,” Jimit Arora, Vice President of IT Services Research at Everest Group, told Nearshore Americas. “You could argue that it’s not happening as much in the emerging markets like Latin America where there aren’t as many large IT outsourcing contracts that can be broken apart, but in more mature markets like North America we’re definitely seeing it.”

IDC Research Director Xiao-Fei Zhang agreed that the trend is currently less pronounced in Latin America. “Businesses in Latin America tend to be a little more conservative when it comes to new delivery models,” he told Nearshore Americas. “Places like the US and the UK are just more brazen when it comes to what value they get and they’re not afraid of dumping existing vendors and changing relationships, whereas Latin America is more about relationship-building and it’s a little bit less competitive. But the current economic situation in Latin America will probably force some companies to look at new delivery models.”

What’s Driving This?

“The biggest driver is the generation of this new technology that companies want to be able to take advantage of. Clients are quite eager to try out new value propositions which allow them a lower cost of service delivery,” Arora said. “On one level it’s just about reducing the workloads that need to be in your data center environment. So you want more flexibility and control and you don’t want to lock yourself down to an agreement that is five or seven years long when technology lifespans are really shortening. So Cloud definitely played a really big role in terms of driving this.”

Scott Feuless, Principal Consultant at ISG, agreed that new technology is behind the shift, noting, “the number of service providers each company uses will grow dramatically, driven by growing popularity of Cloud in general and Software-as-a-Service [SaaS] in particular.” ISG found that standalone contract volumes in ITO have risen sharply in application development and maintenance, largely due to clients wanting faster results, while in BPO, standalone activity in human resources outsourcing was especially high in 2013, “driven in part by client desire to quickly add new functionality without going through a full-scale solution upgrade or replacement.”

However, Zhang, who has been tracking outsourcing deals through the IDC database over the last 15 years, believes that there is a cyclical nature to this phenomenon and that “after a few years we might see services become more centralized again.” He explained: “Looking at the larger outsourcing deals you definitely have this boom and bust cycle. We have seen customers go through periods of breaking a lot of deals into smaller pieces and then after a few years they put them all back together, only to do it all again a few years later. If they get too many vendors then after a few years they’ll consolidate because that generates savings.

Zhang also partly attributes the current rise in multisourcing to what he believes is the shrinking role of contemporary CIOs. “IT used to be very centralized but now our research has shown that significant portions of funding are no longer centralized within IT departments,” he said. “As the overall budget gets split up into smaller portions between different business units it gives vendors greater opportunities to infiltrate the organization.”

ITO/BPO Split

While multisourcing has clearly taken off in areas such as IT infrastructure and application development, it is far from becoming the norm across the entire outsourcing industry. According to the latest available data from a KPMG study of global ITO and BPO deals, the average contract value of ITO deals dropped by under 25% in the third quarter of 2014. In the same period there was an increase of over 25% in the number of all outsourcing contracts with tenure of under a year, while the number of contracts with tenure of over five years fell by more than 25%. This supports the theory that shorter, less lucrative deals are becoming more common, particularly in ITO.

However, the average value and total number of BPO and bundled deals also rose by over 25% in the third quarter of last year, while contracts with tenure of under a year accounted for just 2% of the value of all deals signed in this period. This indicates that while multisourcing is becoming more prevalent in ITO, bigger, bundled deals remain popular in non-IT outsourcing. The data confirms that there is a significant split in this trend when you compare ITO and BPO. Bundled services accounted for just 13.7% of the total value of ITO deals signed in the third quarter of 2014, but in BPO bundled services accounted for three times as much: 37.9% of total contract value.

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ISG also noted that despite niche service providers gaining market share in most service lines, established multinational service providers still receive the majority of revenue from outsourcing deals while bundled contract activity is still on the rise in some BPO service lines.

The reason for this is that multisourcing is simply impractical in some sectors, Arora said: “In say finance and accounting outsourcing it wouldn’t necessarily be appropriate for people to take more of a piecemeal approach and say ‘Okay my accounts payable is with someone, my balance sheet is with someone else.’ Traditional contracts just aren’t structured that way and it probably doesn’t make sense to unbundle it.”

Instead of unbundling, Arora explained, “we’re actually seeing the opposite in the applications services world where people have traditionally used a lot of providers, so it’s been largely fragmented, but now there’s a lot of focus in terms of consolidating expenditure across fewer vendors.” He continued: “At least on the applications side the effort is to consolidate and in a lot of the other BPO areas the portfolios are reasonably consolidating. In the finance and accounting market one of the things that we’re observing is that people don’t necessarily want to renew with the same incumbent but I don’t see the desire to break it apart when they do renew.”

Complications of Multisourcing

If buyers are to outsource functions to multiple vendors instead of a single service provider then they must be able to manage and coordinate this activity effectively. “It is harder to manage multiple vendors,” Zhang said. “Very large clients will always have multiple vendors and they’ll sometimes have all of them coming in and working together. I don’t really think that works well, it’s inefficient because they’re competing with each other. But if you’re splitting up your functions by vendor that’s technically a lot easier to do.”

In order to mitigate this challenge, many businesses are introducing new governance models and either appointing internal service integration and management coordinators or hiring third parties to oversee integration. This is proving increasingly important in order to ensure that there is no drop in quality because of technical incompatibilities or a lack of cooperation between the buyer and its various service providers.

“Managing service providers, due to increasing application focus and the commoditization of infrastructure, will take on characteristics that we see in software portfolio management today – elimination of duplicated and unused services, allowing for growth, negotiating and negotiating again,” Feuless said. “Integration will be absolutely critical and is likely to be the key differentiator between one organization’s IT effectiveness and another’s.”

Implications for Big Vendors

So with smaller service providers taking a larger share of the market in certain sectors, how are larger vendors responding to this disruption? “If you look at some of the large infrastructure outsourcers like HP, IBM, etc. in the Big Data outsourcing environment, there is a big anti-incumbency wave where the desire of clients is not to renew with some of them,” Arora said. “A lot of that has to do with the current levels of client dissatisfaction with the lock-in type model that they were forced into. Their businesses are demanding that they become a lot more agile in terms of responding to changes in the technology world.”

Arora continued: “There’s a lot of recognition in the marketplace that the traditional model is not going to cut it. If you look at the investments that are being made, they’re all in the next generation of technology. The bigger guys are making investments in Cloud technologies and trying to become more flexible because that’s one of the biggest sticking points that clients have.” He concluded: “There’s definitely some responses that we’re seeing in the marketplace but it’s hard to drive such large-scale cultural change and that’s why you’re going to see this trend continue.”

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