If You Can, You Must

The next 12 months will see more of the same when it comes to the growth of IT outsourcing but with some interesting twists as companies get comfortable sending work offshore, while at the same time focus more on limiting risk.

Businesses will continue farming out an increasing number of tasks to service providers in low-cost countries, with new countries joining that roster and existing ones expanding into more advanced functions.

To lower risk, companies are working more often with multiple vendors. The last year provided many examples of businesses moving away from massive, multiyear deals with a single service provider and instead being more selective about what they outsource to whom. ABN Amro last fall handed the bulk of its IT operations to five outsourcing vendors as part of more than $2 billion worth of contracts that involve 3,200 jobs. More buyers of outsourcing services are splitting tasks such as infrastructure management, application development, and help-desk services among a few well-chosen partners.

This year's marquee example is General Motors Corp., which will hand IT work previously allocated primarily to EDS to multiple vendors, which could include the likes of IBM, Hewlett-Packard, and Capgemini.

Next Up: Infrastructure
The new year also will see an expansion of the kind of work that gets sent offshore. Infrastructure management--long viewed as a job that requires on-site managers--may be the next big thing to go offshore, thanks to new remote monitoring and provisioning tools. "Executives now say that if it's possible, they better do it, and offshore infrastructure management is now possible," says Peter Allen, a managing partner at outsourcing advisory firm Technology Partners International.

"Offshore" is no longer a synonym for India. This year will see an increase in the trend among businesses to diversify geographic centers in the same way they're looking for diversification among vendors. The main driver is the fact that India's cost advantage--while still substantial when compared with most countries--is declining as increasing demand for labor causes wages to rise. "India is getting strained in terms of resources," says Moors & Cabot analyst Cindy Shaw.

Average professional wages in India could rise up to 6.7% in 2006, says consulting firm Employment Conditions Abroad. That means China, Eastern Europe, and South America will get harder looks as low-cost outsourcing destinations. "India will maintain its stronghold as an offshore destination for U.S. companies, though the country will face competition," offshore advisory firm neoIT says in its 2006 trend report.

Indian vendors aren't banking on cost advantages. Infosys, Tata Consultancy Services, Wipro, and others will work aggressively to move into higher-value markets this year, well beyond their traditional strongholds in application maintenance and development. Some Indian players will acquire small U.S. consulting and business-process-outsourcing companies with vertical-industry specialties, Shaw predicts.

The BPO market will continue its double-digit growth, particularly in specialized areas such as human-resources and finance and accounting outsourcing. HR outsourcing is the hottest segment in the BPO market, with the Yankee Group predicting sales in that sector will hit $14 billion in 2009, compared with $4.6 billion this year.

And new higher-value BPO markets are expected to grow, led by top vendors such as IBM and Accenture that are working to standardize processes involved in activities like design and research and development. The pharmaceutical industry could be among the first to take advan-tage of high-end offshore offerings such as clinical research and testing, Technology Partners' Allen says.

This year could see domestically driven changes in the vendor landscape, as midtier players become acquisition candidates. Will it be the year that Deloitte finally follows its Big Five accounting brethren and spins off its consulting and systems integration arm into a separate company? The others did so after industry watchdogs charged that their acceptance of big consulting and integration fees from accounting clients compromised their neutrality. Investors this month forced bankrupt Delphi Corp. to fire Deloitte as its auditor after claiming Deloitte suffered from just such a conflict of interest inside the auto-parts supplier.

And while a deal for Lockheed Martin Corp. to buy Computer Sciences Corp. collapsed late in 2005, CSC remains a takeover target. General Dynamics Corp.'s $2.2 billion acquisition of Anteon International Corp. could spur Lockheed to take another pass at CSC. It's particularly crucial because the federal government is poised to award some extremely lucrative contracts in 2006 that call for strong competencies in IT systems related to defense and homeland security. The Department of Homeland Security's Eagle project alone should be worth about $5 billion.

That's more fuel for a growing fire. The global market for outsourcing services hit $84.6 billion in 2004, research firm IDC says, and should grow 6% in 2005 and again in 2006.