A mixed picture indicates that the HRO market is nothing to get excited over this year. More second-generation contracts may be the most frothy development in the months ahead.
EquaTerra recently completed its Q4 quarterly pulse survey with those on the front lines of the outsourcing industry—its own global advisors and the industry’s service providers—and the numbers paint a mixed picture.
These quarterly surveys, which commenced in 2004, offer in-the-field insights into sector trends and projections. Each quarter, more than 100 EquaTerra advisors and approximately 20 service providers answer questions on the BPO and ITO markets on a proprietary and confidential basis. Key findings from the fourth-quarter survey and projections for the first half of 2007 are described in detail below.
Only 46 percent of advisors indicated that demand for outsourced services was up for the quarter, a decrease of 13 percent from both the third quarter of last year and the fourth quarter of 2005; this figure was down nearly 50 percent from the 85 percent level cited in the final quarter of 2004.
BPO and ITO service providers polled were generally positive on new-deal pipeline growth projections. The percentage citing stronger pipelines rose to 61 percent from 48 percent in the third quarter of 2006; however, they also said pipeline growth was down compared with the 67 percent reported a year ago (and against the average over the life of the survey). A minority (35 percent) of service providers indicated that pipelines were flat, and just four percent said they were lower quarter over quarter, compared with nine percent of respondents feeling this way in the third quarter of last year. It is important to highlight, however, that service providers still see demand growing, albeit at slower rates.
Service providers’ and EquaTerra’s functional demand rankings were generally in sync for the quarter. HRO, which has consistently ranked as the leading area cited by service providers, slipped behind ITO (29 percent and 33 percent respectively) in service provider rankings for the last quarter of 2006; 29 percent is the lowest total for HRO since the Pulse Survey first began. FAO took third place in demand rankings at 24 percent, although that number was also down from prior quarters.
The quality of the deal and the ability to execute are two of the most critical factors affecting profitability. It is important to note that the Pulse Survey question on profitability addresses existing contracts that have been executed, not new deals in the pipeline.
The number of service providers polled who reported improved profitability rebounded strongly in the quarter, reversing three quarters of declines. The majority (63 percent) of service providers reported improving profitability, up from 48 percent in the third quarter and down from 71 percent from the same period a year ago. The balance reported stable levels of profitability with no declines. Improved profitability is expected, given that service providers cited decreased pricing aggressiveness in the first half of last year. There is a lag between pipeline pricing pressure/relaxation and its impact on existing, con
summated deals.
According to EquaTerra advisors, sales cycles remained relatively flat quarter over quarter and year over year. Among advisors, 78 percent—the highest during the lifetime of the Pulse Survey—indicated that sales cycles were about the same in the fourth quarter as in the previous quarter. Just 16 percent—down from 31 percent at the start of the year—indicated sales cycles were lengthening. While the Pulse Survey does not measure the absolute length of sales cycles, EquaTerra estimates that for larger deals (those with more than $100 million in TCV) that are competitively bid, the sales cycle can take six to 12 months from the time the buyer goes to the market until the deal is closed.
Demand growth flattened in the last quarter of 2006 after two periods of improvement, while contract values remained mostly stable. Although demand is growing, service provider capacity remains tight and deal pursuit selective in the BPO market. Deal restructurings continue to increase, although incumbents continue to retain the majority of the business. Profitability and service provider capacity continue to improve, and the number of re-competes and renegotiations continue to grow, but at a slower pace. Multi-sourcing continues to be more common than sole sourcing, affecting deal size, scope, and the competitive service provider landscape. Overall, 2006 was a slower year than 2005, and trending points toward a flat first half of 2007.
