The State of Outsourcing IT

The market for outsourcing services is shifting as U.S.-based customers divide their outsourcing work among more providers, build in simple ways to break contracts and hire more U.S.-based software-as-a-service providers in addition to offshore outsourcing services.

An upcoming Gartner, Inc. report, estimates that the value of IT and business-process outsourcing contracts dropped by half during 2007.

However, according to Kurt Potter, the Gartner analyst who was lead researcher on the study, the total spent on outsourcing isn’t dropping; end-user companies are just spreading the work out among a larger number of providers, rather than relying on a small number of big-dollar contracts with IBM, EDS and other traditional providers.

Potter, who says the tactic is relatively new, calls it multisourcing and warns that it introduces more complexity into outsourcing contracts — both during negotiations and afterward, as companies try to manage more contracts and IT services vendors.

A recent IDC study of international outsourcing deals shows multinational companies are including factors in outsourcing contracts that are explicitly designed to allow the customer to renegotiate even long-term contracts when they see the need, according to Aprajita Sharma the IDC analyst who was lead researcher on the project.

The increase in price benchmarking, ‘claw-back’ and ‘blue-sky’ clauses in offshoring contracts give customers more flexibility by creating specific goals that, if an outsourcer fails to reach, can trigger a renegotiation. But, Sharma writes, those options can also drive up costs.

End-user companies aren’t the only ones outsourcing IT functions, though, according to a March study from accounting and consulting services company BDO Seidman, which surveyed the CFOs of U.S.-based technology companies on the topic.

Almost half (49 percent) of technology companies send some non-core work overseas, mostly manufacturing. However, 51 percent offshore IT services and programming, 49 percent send R&D overseas and a third support offshore call-centers.

Even with increased costs, however, the average length of the outsourcing contracts U.S.-based customers signed with IBM, EDS, CSC and other traditional suppliers got slightly longer during 2007, showing that traditional outsourcing is still a strong part of an IT services market IDC predicts will be worth $746 billion this year, up 6.8 percent from 2007.

Though it’s the smallest part of the outsourcing market, hosted applications are growing faster than any other part of the IT services market, at 15.9 percent per year, according to IDC. Immediately behind hosted applications are business outsourcing services, which are growing at 10.4 percent, the study says.

Application hosting — software as a service and other slices of the hosting market — is attractive to many companies because the software itself is relatively generic, and renting it means the customer doesn’t have to keep track of licenses, patches, version control or, more importantly, the skills the applications require for maintenance, according to Ray Homan, CEO of asset-management software developer BDNA Corp.

"Some companies want to have their applications on the premises and manage it themselves, and other want a time commitment or time-to-value argument for an investment," Homan says. "SaaS is more around the risk of identifying, training and retaining the skills you’d need for that software, though, not so much the capital expense of acquiring it."

Only 27 percent of CIOs polled by Gartner at the end of 2007 believe they have the right number of people with the right skills to meet all the needs of their business, and said outsourcing is a key way to alleviate that lack.