Infosys Ltd and Tata Consultancy Services Ltd announced their Q4 results last week, and the rest will follow over the coming days. However, investors cannot act upon the information in the absence of industry-wide data. Since Nasscom is refraining from providing a growth benchmark, investors will look for the vacuum to be filled by analysts and consulting firms.
One such is ISG, my former employer. It puts out a quarterly view of the industry called the ISG Index. Since outsiders’ visibility gets murkier as deals get smaller, it refrains from commenting on deals that are smaller than a certain size ($5 million presently) in annual contract value (ACV). Nonetheless, its methodology is robust, and it produces a startlingly accurate view of the deal cycles in the industry.
I recently met Michael Connors, chairman and chief executive officer of ISG, who along with Bret Breeding, ISG’s data czar, proceeded to give me an education.
This column will focus on numbers, since it will highlight some aspects of ISG’s research that are germane to the current earnings season.
According to Connors, though there are macroeconomic headwinds on the horizon, ISG continues to forecast steady growth over the next several years in both the IT and business service segments globally.
ISG’s trailing 12-month growth numbers for the traditional sourcing industry clock in at 8%, yielding a number of $27.5 billion in ACV. Meanwhile, the “as-a-service" market, which includes everything that is cloud-based, has grown at 37% on a trailing 12-month basis and now almost equals traditional services outsourcing, clocking in at $23.6 billion for the year. Combined, these numbers show a trailing 12-month growth of 20%.
These counts are for the commercial sector only; they do not include government deals and only focus on deals that are above ISG’s $5 million visibility floor. Smaller deals are difficult to trace, but these broader market numbers still suffice as a guide to the overall health of the IT industry.
Interestingly, ISG’s data shows a general decrease in ACV from approximately $20 million to $15 million from 2010 to 2015, followed by stabilization since then at the $15-million mark. The more telling statistic is that there are many more awards coming to the market in the smaller ACV bands. In 2018, the broader market finished with 60% of its awards in the smallest ACV band of $5 million to $10 million versus 2010, when this number stood at 46%. This means that despite splashy headlines, the main battles are not being fought in the mega-deal space, but in the small- and medium-sized bands. For a detailed look at these numbers, I suggest you see the ISG Index here.
What is driving the reduction in deal size?
First, deal duration decreases since software and hardware assets included in previous deals are now accounted for elsewhere and are not depreciated over long-term tenures. The 10-year deal is now a 3.5-year deal.
Second, software applications get replaced or shifted to the cloud. For example, let’s say there were 100 applications that were part of the original deal and that half of those would move to a public cloud during the contract. That means half the service provider’s workload for computing and support would now be shifted to a cloud provider such as Amazon Web Services or Microsoft’s Azure. Meanwhile, other software applications would be replaced by cloud solutions like Salesforce or Workday. This results in decreased spend with the traditional service provider.
However, there is some consolation. New digital services counteract to some extent the revenue losses to the cloud. Nobody can go digital without a service provider. Here’s how digital plays out in different verticals:
One, the digital demand trends for banking and insurance are in cloud migration, cybersecurity and intelligent automation. Digital investments have also accelerated in wealth management and commercial banking. As interest rates rise, enterprises should see their profitability expand, and they will be more optimistic about spending.
Two, in manufacturing, digital spending has begun to rise as companies shrink their product development cycle and reinvent the supply chain from research and development to production to sales to customer care. Investments are aimed at 3D printing, autonomous technology and solutions to meet the demand for digital manufacturing and engineering services.
Three, the energy industry’s volatility comes from the fluctuations in crude oil prices, causing companies to continually evaluate their capital spend to manage profitability. Firms in this vertical tend to invest in the Internet of Things and robotic process automation to enhance efficiency and reduce costs.
Four, retail clients continue to strengthen their digital business channels to enhance frictionless omnichannel experiences, personalized “market of one" retailing and responsive supply chains.
Five, the healthcare and pharma industry shows a growing interest in analytics programmes and an ongoing demand for cloud migration initiatives, but digital has not permeated the sector as much because of stringent regulations in the space. For healthcare providers and payers, the focus remains on improving efficiencies and advancing patient care and satisfaction.
The bottom line is that ISG expects digital growth to stay robust and to top 25% this year while the overall market itself will expand by 3.2% on a constant currency basis. The game has been redefined, but the prize money is still large.
Siddharth Pai is founder of Siana Capital, a venture fund management company focused on deep science and tech in India.