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Opinion | A market trend that’s reshaping the infotech services sector

Traditional information technology service companies need to adapt to a significant uptrend in ‘As A Service’ offerings

After each quarter’s earnings announcements, I usually pen a column that analyses the performance of the information technology (IT) services sector. This time around, I felt it better to wait until the excitement (or despair) after the July earnings announcements by IT services firms has petered out. This time, I thought it might be useful to have a look at the nuances of the market that affects all players in the space.

Plenty of information is already available on a firm-by-firm basis and stock analysts spend time contrasting performances and outlooks across firms. This, in an attempt to guide their clientele who are making investment decisions. These analyses result in “ratings" where analysts call out their recommendations, such as “buy", “hold", “accumulate" or the dreaded “sell". These financial analyses are thorough, but depend on each firm’s commentary to a large extent. Net new hiring is a strong indicator, as is the number of large deals won. They also rely on indicators provided by IT services companies of the relative strength or weakness of deal flow across industry sectors. Financial services is always the biggie, followed by business services, manufacturing, and so on. To my eyes, however, the categorization of such sectoral strength or weakness in demand is usually based on anecdotal evidence. To get beyond that, analysts are forced to look at past transactions that might be coming back to the market to be re-competed in a new avatar.

Then there is the rush to label work as “digital" or “industry 4.0". This category is notorious for its reporting inaccuracy, largely because the measurement of these types of projects is fungible. Each IT services firm has its own definition of what fits into this space and analysts have to accept such classifications prima facie.

Adding to the uncertainty around sectoral analyses and the shift to digital is the “funk" around the global economy. India’s economy is in a downturn. The ongoing trade war between China and the US looms over us all. It is a dangerous zero-sum game. Both economies will be impacted as a result. The uncertainty around Brexit is also causing jitters. Stock markets the world over are volatile and react sharply to slight changes in policy and trade positions taken by each country.

There is now talk of a global recession. Contrary to popular belief, the IT services market is not recession-proof. It suffers downswings just as much as any other industry segment. Such knee-jerk reactions are a sign that investors and their advisers are bereft of real information that they can use to make trades with certainty. In this sort of scenario, it is always useful to have real numbers on which analyses can be based—and investment positions taken.

Recently, I turned to Michael Connors and Steven Hall, chairman and European president, respectively, of Information Services Group Inc. (ISG). Thanks to its data czar Bret Breeding, ISG has the best data around buying activity in the IT services space and has a deep insight into how that market is shaping up. It helps that I spent more than a decade as a president for Asia-Pacific and as a member of the executive board of the firm. Connors and his colleagues have been generous sharing their proprietary information with me, though it is now more than four years since I left the firm and all ownership interest in it behind.

The most interesting pieces of ISG’s analyses ran along two vectors. The first is the shift from traditional managed services, which IT services firms dominate, to the “As a Service" space, which they do not. That second space is the preserve of Big-Tech firms such as Amazon and Google’s Web Services subsidiaries, and Microsoft’s Azure. The growth of “As A Service" offerings has far outpaced the Managed Services space for the last five years. “Software As A Service" and “Infrastructure As A Service" have grown at a compounded annual growth rate (CAGR) of 13% and 33%, respectively, while Managed Services in the IT space has remained near stagnant at 1% CAGR and BPO Managed Services have declined by 2%.

The second vector is the analysis that shows vastly varying figures for Annual Contract Values (ACV) of outsourcing deals struck across various industry sectors. ISG provided information across eight different sectors. Of these, I will only discuss the most salient of them—the largest sectors with consistently high demand during the first half of 2019. Financial Services, with a total ACV of $6.1 billion through the first half, had a combined growth rate of 5%. When one looks under the covers though, the 5% was comprised of only 1% growth in managed services and 21% growth in As A Service business. Similarly, Business Services showed a huge increase of 17%, fuelled almost entirely by growth in As A Service contracts. Manufacturing showed a healthy increase of 32%, comprising both old-style Managed Services contracts (at 38%) and As A Service deals at 25%.

It would appear then that with the exception of manufacturing, the continued growth of the outsourcing business is hinged on the growth of As A Service offerings. I would suggest we stop looking at what can be termed “digital" and focus on the As A Service space instead as a harbinger of the future. In the case of As A Service, at least the deal sizes and the availability of hard information based on actual contracts is a more reliable metric on which to base analyses and decisions, rather than speculation about “digital" work.

Siddharth Pai is founder of Siana Capital, a venture fund management company focused on deep science and tech in India.

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