Hello. This is Stanton Jones and Mike Rose with what’s important in the IT and business services industry this week.
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What You Need to Know
Contracted prices for IT managed services are declining at unprecedented rates. While AI is contributing to the price performance, other market forces are also at play.
Data Watch
Background
There are many reasons enterprises choose to buy technology managed services. Speed, variability, a source of talent, to name a few. But the most important factor for most organizations has been – and continues to be – cost savings.
It’s been a longstanding principle that managed services prices decline year over year. While labor rates tend to go up, managed services prices tend to go down as providers drive productivity into their offerings to stay competitive in an exceptionally competitive marketplace.
You can see this effect in this week’s Data Watch. In the past, resource unit prices have come down between 10% and 20% by the end of the second year of a contract. This applies to all IT towers, including application managed services (AMS). We call this change in price over time “price performance.”
But something has changed more recently. In the last 12 months, price performance has accelerated – a lot – doubling or even tripling in some cases. That means that, for example, a server RU (within the “infrastructure” category above) that cost $20 at the start of a contract now will cost $16 at the end of the second year instead of $18 as it has in the past.
That means contracted improvements in price performance for IT managed services at the two-year point have doubled in comparison to the historical average.
Why It’s Happening
Given the explosion of innovation happening around generative AI, it’s easy to just use “AI” as the reason for this big change in managed services pricing. But it’s more nuanced than that.
While providers are indeed making significant progress in driving both traditional and generative AI into their service delivery, and it absolutely is having an impact on provider productivity, it is not entirely clear yet how much is due to AI versus other market forces.
We’ve talked a lot about how competitive managed services is. It’s a big, wide industry with hundreds of players. And that number is only increasing as other types of services like consulting and systems integration remain under pressure given the continued business uncertainty in the market. This means the growth is largely in managed services, so providers – both new and traditional – are pricing to win.
This means that providers are betting today on their ability to use AI to profitably deliver (at the end of two years) on these newly contracted price points.
And this in turn is creating an interesting dilemma in the market. Providers are taking on more risk while clients must wait (two years) to realize the benefit of AI. My colleagues on the advisory side have a framework to address this growing gap. We call it Autonomy-Level Pricing. We’re actively working with a handful of clients and providers on this new pricing framework, and we’ll be talking a lot more about it at our AI Impact Summit in New York City on November 17-18.
You can register here.About the authors
Stanton Jones
Stanton helps enterprise technology leaders, IT service providers and buy- and sell-side professionals make sense of the global IT services sector. Stanton's weekly briefing - the Index Insider - is read by thousands of industry stakeholders each week.
