What is Happening?
On April 12th, we held our 58th quarterly Index call summarizing the state of the combined sourcing and as-a-service industry for global, commercial, and public sector contracts over $5 million in Annual Contract Value (ACV). Key takeaways from the call included the following:
- First-quarter ACV for the combined global commercial market (including both as-a-service and traditional sourcing) reached $10.5 billion, up 12 percent over the first quarter last year and up 13 percent from the fourth quarter of 2016.
- In the public sector, the combined market ACV, at $12.9 billion, was down 21 percent year-over-year, yet rose 17 percent from the 2016 fourth quarter. Traditional sourcing, which still represents the lion’s share of spending in the public sector, was $12.5 billion, down 22 percent, while as-a-service ACV in the public sector, at $0.4 billion, was up 31 percent.
- Human Resources Outsourcing (HRO), a leading indicator for the sourcing market, is seeing a shift from services-led sourcing to platform-led sourcing, whereby companies are place bets on cloud platforms (e.g., Workday or Amazon Web Services), then sourcing implementation and managed services to fit their technology strategy.
With a combined ACV of $23.4 billion this quarter for both commercial and public sectors, performance was a full 15 percent higher than the prior period – but did not quite meet the level of a year ago. From a trailing 12-month perspective, the combined market ACV contracted somewhat as traditional sourcing settled down after a very strong prior period and returned to what it was two years ago. As Figure 1 illustrates, as-a-service ACV continues on a fairly steep upward trajectory.
Figure 1: Global Commercial and Public Sector Quarterly ACV ($B). Source: Q1 2017 ISG IndexTM
As seen in Figure 2, financial services companies generated $8.4 billion in ACV during the trailing 12 months, a 15 percent increase over the prior 12 months. The rapidly increasing as-a-service market comprises 29 percent of total financial services ACV this year. Business Services emerged as another strong performer with an increase in ACV of 26 percent over the prior like period, and a considerable 80 percent increase from two years ago. As-a-service contracts account for 63 percent of Business Services ACV, indicating this industry’s particular reliance on the cloud.
Figure 2: Industry Details for Trailing 12 Months ($B). Source: Q1 2017 ISG IndexTM
Meanwhile, the gap in contract value between traditional sourcing and as-a-service continues to close. The left bar chart in Figure 2 delineates the difference between the commercial and public sector markets, in which the gap in contract value has not yet emerged.
Why is it Happening?
In the commercial sector, the gap between traditional sourcing and as-a-service sourcing differs by industry vertical. While the financial services industry generated $3.8 billion in total ACV during the prior 12 months, which is a steady rise over the past two years, as-a-service accounts for more than a third of its total market ACV, up from 25 percent two years ago. This activity confirms the fact that this industry has typically been the fastest adopter of new technologies and solutions.
Cloud infrastructure providers such as Amazon and Google serve this specific market segment across a broad base of customers, from startups to midsize businesses and large enterprises.
Telecom and Media use of the cloud is also on the rise, despite short-term uncertainties due to industry consolidation. As-a-service ACV accounts for more than half of its total market ACV, up from 31 percent two years ago. In Manufacturing, digitization of the supply chain may account for some of the strength in as-a-service spending, which now accounts for 41 percent of total market ACV.
For the public sector in the U.S., transitions after two-term presidents generally involve disruption, so we expected ACV over the past several months to be subdued. And, indeed, the number of large deals dropped from 75 in 2015 to 55 in the current trailing 12-month period. Public sector ACV in EMEA has traveled a bumpy road over the past three years, bottoming out in the past 12 months. For both the U.S. and EMEA public sector, enterprises can embrace as-a-service offerings only as quickly as they meet regulatory and compliance requirements.
Commercial IT services spending is shifting rapidly. In 2014, 30 percent of spending was on as-a-service. Today, that number is nearly 46 percent. This rapid shift in spending from traditional sourcing to as-a-service signals that generation-three relationships are in full swing. These next-generation relationships leverage software in favor of labor arbitrage, use agile delivery models to increase speed and reduce risk, and rely on standardized, massive-scale clouds as the underlying delivery platform.
For example, automation will continue to drive up service provider productivity levels, drive down delivery costs, and encourage buyers to adopt more standardized as-a-service offerings all while increasing service provider profitability (assuming they choose not to pass this on to customers in order to win work). Cloud will be the future delivery model of choice, as 50 percent or more of enterprise workloads move to the public cloud by 2020. This once-in-a-generation shift will force large Indian and Western heritage service providers to shift their delivery model from managing assets to managing services. It will also favor leading SaaS and IaaS vendors, who are quickly cementing their market dominance as companies increasingly move to a platform-based sourcing model.
In the public sector, the story is somewhat different. At only 3.1 percent of public sector spending, the as-a-service segment still represents a small share of the total market, as governments have yet to embrace cloud-based services as strongly as the commercial market. As more massive-scale clouds become certified by federal governments, we expect healthy growth in public sector as-a-service adoption. For example, the U.S. Department of Defense recently granted Level 5 accreditation to Microsoft for its Azure and Office 365 offerings, making it the only commercial cloud provider operating at that security level. As other providers gain similar accreditations, platform-based sourcing will increase dramatically in the public sector.