Global Sourcing: The Hits Keep Coming

All things digital continues to grow unabated

The global outsourcing market seems almost invincible. It continues to rack up records quarter after quarter, as demand for all things digital continues to grow unabated. Indeed, we’re starting to sound like a “broken record” in our ISG Index™ calls, for those of you who remember LPs. (Excuse the pun.)

To extend the metaphor for only one more paragraph (I promise), the string of records in the third quarter and over the first nine months is almost as long as the number of hits in the Billboard Hot 100. They include (for the third quarter) combined market annual contract value (ACV) and growth rate, as-a-service ACV and growth rate, IaaS and SaaS ACV and growth rates, managed services ACV and contract volume, and business process outsourcing ACV.

And that’s only at the global level. Many other records were set at the regional level, by service area, and for the year-to-date period.

Not much to fear from inflation in managed services

So, what’s going to hold back this digital tide? Not much, in our view. At least not for the foreseeable future.

Of course, there’s the specter of inflation, which is causing agita in many sectors, but not in technology and business services—at least not for the buy side.

Enterprises don’t have much to fear from inflation, as the agreed-upon rates and inflation clauses in managed services deals, often signed for three to five years, make it very difficult for providers to raise their rates. Shifting to automation, implementing process improvements and pivoting to less labor-intensive or non-linear revenue strategies will help, but providers will continue to see margin pressure—likely through 2022.

SaaS – As-a-service providers face high attrition rates

SaaS providers, on the other hand, seem willing to trade off price increases for relationship stability. One of the important trends we’re seeing in the SaaS sector is the heightened discussion of contract backlogs, or Remaining Performance Obligations. Many vendors are highlighting these RPO metrics as a leading indicator they’re seeing longer contract durations. A multiyear contract gives the customer price certainty in exchange for what the provider hopes will be a longer-term strategic partnership.

Then, there’s the non-digital component of the services industry, namely, human talent.

You’ve heard about The Great Resignation—people leaving traditional employment in search of better pay, flexibility or quality of life. The technology and business services industry has not been immune to that trend, and it is bringing about a fierce battle for talent.

Industry attrition is high—likely near its peak—as providers report attrition rates 500 to 1,000 basis points higher than normal. In India, some firms report half their young digital talent has left to seek other opportunities. Organizations are using all the tools at their disposal to lower attrition, but this often means more spending, which is impacting margins. 

Companies are increasing campus and lateral hires and using more subcontractors, but it takes time to ramp up resources with training programs. That costs money, as does the need to backfill with more expensive resources in the interim.

The sheer number of resources required to support the demand is amazing. Over the last 12 months, the industry has added $4.5 billion of ACV in engineering and applications, requiring more than 100,000 new software engineers. This doesn’t include the talent needed for digital transformation projects within enterprises or the massive hiring currently taking place by hyperscalers and SaaS providers.

Digital engineering in the red-hot engineering services market

In our 3Q21 ISG Index call, ISG partner and global head of digital engineering Gaurav Gupta explains what’s going on in the red-hot engineering services market. It’s well worth listening to the replay of our call to learn more about this all-important “umbrella” capability that is the backbone of all digital transformation.

So, what to expect in 2022?

Given all the tailwinds we see in the managed services and as-a-service markets, we’ve raised our 2021 forecast in both sectors. We’re now expecting 10.1 percent growth in managed services, up from 9 percent last quarter, and 25 percent growth in cloud-based infrastructure and software services, up from 21 percent a quarter ago.

That’s 2021. For 2022, we still see overall demand remaining very strong, but keeping in mind some possible headwinds.

First are the supply chain issues in manufacturing and CPG exposed by the pandemic. This will cause funds to be shifted to fix the problems. Some, but not all, will be digital solutions.

Second is the supply-and-demand issues around talent. Wage inflation and significant surges in the need for talent will continue to pressure the market for at least another year.

And, finally, the favorable year-over-year comparisons in 2021 against last year’s pandemic-induced softness are not likely to be replicated. While we fully expect the apps, engineering and as-a-service markets to continue expanding, there will be pressure on traditional data center and ITO work that could impact 2022 comparisons.

To get a fuller picture of current market dynamics, view the 3Q21 Global ISG Index™ webcast replay, presentation slides and press release on our the ISG Index page of our website.

For a quick video summary, I encourage you to watch the latest edition of “ISG Index™ Headlines” on the same page or on YouTube.

Finally, we invite you to sign up for our weekly ISG Index Insider™ briefing. We’ll announce the date of our fourth-quarter ISG Index call in an upcoming issue.

Until we meet again in mid-January, stay healthy and safe.