UK: Volume Up, Value Down: A Growing Trend In Sourcing

The second quarter of 2015 saw a record high in the number of sourcing deals, globally. But, while volumes are increasing and the market appears to be growing, the annual contract value and duration of these transactions continues to decline.

Recently released data from ISG, a global technology insights, market intelligence and advisory services company, showed a record high of 451 outsourcing contracts signed in Q2, and a total of 754 agreements in the first half of 2015. However, the ISG Outsourcing Index, which provides a quarterly review of sourcing industry data, also showed that during Q1 of 2015 the annual contract value was down 14 percent from the previous year.

Why are we seeing this increase in deal activity but a decrease in contract value? Is it solely the move toward automation and greater digitization causing a decrease in price? Or are there other factors to consider? Does this trend have the capacity to fundamentally change the way customers contract for third-party services and if so, what can customers expect?

Migration from Traditional Sourcing

While a greater number of smaller deals in the marketplace is not a new trend for 2015, we also have seen greater migration away from the traditional, tower-centric solutions and dedicated data centers. Instead, more customers are opting for application-centric solutions and shared data centers where specialized services are provided by smaller, niche providers. This migration has meant a definite shift away from sole-source environments where large, global suppliers have a function-wide scope, providing the end-to-end environment including management and maintenance of assets. Instead, customers are now separating asset purchases from services and choosing suppliers by service scope rather than by function, leading to a multi-sourced environment within a given function.

The "as-a-service" approach to service delivery is facilitating the movement from traditional methods of service delivery with specialist providers capable of offering XaaS (everything as a service). Traditional hardware and software offerings no longer allow enterprises sufficient flexibility to evolve and keep pace with technological advancement, data analytics and data storage and intelligent cost control.

New Technologies

Perhaps most relevant in the IT and BPO markets, customers are seeking opportunities to capitalize on technological advancement. Smaller suppliers, with distinct capabilities in disruptive technologies, are ready with specialized expertise to make that expectation a reality. The pace of change is increasing, and customers need to recognize the importance of rationalizing their sourcing portfolios to take advantage of greater automation and digitization.

Realizing this need will be a key component to a customer's sourcing strategy. It will give customers the opportunity to assess their current sourcing environment and the scope of their existing agreements and to understand where technology can streamline processes. This will facilitate process efficiencies and cost reduction.

But What Does This Mean for the Marketplace?

Customers expect suppliers to know how to take advantage of the technological advancements to streamline and refine processes and significantly drive down pricing. As a result, a more competitive marketplace with greater importance on technology and intelligent cost control is emerging. Suppliers are being forced to adapt, and differentiation is key—in respect of both pricing and service offering. However, it's not all bad news for suppliers. As a result of the move away from the traditional service delivery model, there is likely to be greater opportunity in the marketplace for the small to medium suppliers, providing they have a unique skill set to offer.

Suppliers may also benefit from the impact this trend is having on the contracting process. In the absence of a very sophisticated customer, we are likely to see an increase in transactions done on supplier terms and conditions with limited bespoke tailoring as a more standardized approach to contracting is adopted; reflective perhaps of a more standardized as-a-service solution.

This increase in the number of lower-value deals is likely to impact how customers view the contracting process as well as the cost and time dedicated to each transaction. Supplier selection may become more of a challenge when contracting on supplier terms as comparisons may be more opaque. A more streamlined approach to tendering will surely need to be adopted to allow a true like-for-like comparison before an intelligent supplier selection can be made. Comprehensive RFPs are likely to become less common as the demand increases for a more agile, immediate form of pre-contracting to keep pace with emerging technologies and changing business requirements.

As a result, the contracting process is likely to become more streamlined with a greater appetite for automated documentation and a "light touch" approach to legal input where services are standardized and contracts are lower in value. However, legal counsel should be mindful of the operational and legal risks associated with these complex relationships and recognize that contracts with a lower value (usually because of a more niche scope) are neither low risk nor of low strategic importance to the business or IT infrastructure. Costs associated with the contracting process should be kept under control, but they should not be a main consideration during supplier selection when outsourcing critical services or when reviewing the risks associated with contracting on supplier terms and conditions.

Governance Will Be Key

Service integration and higher levels of governance will become ever more important as the multi-source model becomes more prevalent and the complexity of the relationship between multiple suppliers and retained organizations and functions increase. A multi-source environment with increased IT interfaces, competitive forces and a complexity of roles and responsibilities sounds like a governance disaster waiting to happen. However, complexity associated with multi-sourcing is mitigated and, in fact, capitalized upon by suppliers broadening their service management capabilities to promote governance as a core competency.

However, not all the teams play nicely together and it will be those suppliers that recognize the benefit of providing a specialist service integration offering that will ultimately succeed in this evolving marketplace.

Where such management capability is not offered as a service by a supplier, a customer will have to decide whether it is capable (both operationally and financially) of providing this important governance function itself. In the instances where it is not, there is likely to be an increased opportunity for a new category of IT services professional: the service broker. The service broker might design, source and provide a complete managed service with centralized governance and a heavy emphasis on data analytics to effectively manage a multi-sourced environment as a stand-alone specialist service offering. These contracts can raise their own unique challenges and the complexity of the sourcing relationship will increase for the customer organization. However, contracts with a service integration specialist should provide the customer opportunity to transfer much of these challenges and associated risk to the service integration specialist.

Conclusion

Regardless of the size or value of the contracts in place, it is critical that customers properly consider the contractual and operational risks associated with a multi-sourced environment. Even with increase in lower value contracts, they must implement a robust governance model to address the growing complexity of their third-party relationships.

Previously published in Business & Technology Sourcing Review Issue 22 | Fall 2015

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.