Credit crunch changes outsourcing market

You may be forgiven for feeling fatigued by the wealth of depressing stories surrounding the collapse of the sub-prime mortgage market and the emergence...

You may be forgiven for feeling fatigued by the wealth of depressing stories surrounding the collapse of the sub-prime mortgage market and the emergence of the so called "credit crunch". Those in the IT industry may in particular feel apprehensive as to how it could pan out for them. There is much talk of slashed budgets and downturn trends.

The effects of the credit crunch initially impacted upon the US financial services sector, and although many say that the UK is not as badly affected, the volatility brought about by Northern Rock and rumours of other UK financial organisations in trouble means that the crunch will soon filter down to UK industry as a whole.

Mervyn King of the Bank of England has on two recent occasions demanded that UK banks do more to strengthen their balance sheets so that they can maintain their capital ratios and support lending. But even they are finding it hard to obtain cash from one another to support their liquidity ratios, and soon many sectors of business will find it harder to get their hands on money for investment, capital expenditure and growth.

From now on, the strength of the balance sheet and cash reserves for the financial sector and the wider business sector will be king. Banks are already restricting their lending criteria, and only those companies with healthy balance sheets and capital reserves are likely to be viewed as safe bets by the banks.

However, along with clear threats to the IT sector, there are also potential opportunities. In a recent report the UK's National Outsourcing Association predicted that businesses will look to outsource "high-value-add functions" such as business processing, application development and IT operations, adding that the industry will be boosted by "organisations looking to become more efficient and minimise their risk exposures" by outsourcing.

Offshoring is the obvious answer for many banks and businesses. Reduced costs mean that transactional processing and IT development will be cheaper, giving businesses more bang for their buck.

Although many cautious businesses may consolidate their processes and be wary of spending on IT and outsourcing, there is an argument that suggests that those who spend now could reap benefits when the market turns. They can use IT and business processing outsourcing as transformational catalysts to address operational issues, cut costs and utilise their retained resources to concentrate on core business areas.

Outsourcing, of course, also helps businesses improve balance sheets by raising cash from the sale of existing assets and operations to suppliers and by taking many operational costs off the balance sheet.

All of this is fine, and clearly when cost-savings need to be made, offshoring to cheaper countries makes sense, but what of those IT businesses and professionals left in the UK who see their jobs and contracts move abroad?

The UK IT sector can seek to improve its position by moving up the value chain, identifying areas that are not as cost or downturn sensitive. For instance, supporting and developing systems needed by the outsourcing suppliers, particularly those providing high-end business process outsourcing services, especially in the emerging knowledge process outsourcing sector. Early adopters of knowledge process outsourcing systems and suppliers of bespoke applications might find themselves well placed to weather the current economic storm.

But there are other trends that will appear as costs savings become the watchword of organisations, from which the IT sector could benefit. For instance:

- "Governance outsourcing", in which suppliers offer companies that have already outsourced IT and business processes a contract management and governance service, reducing the cost of managing outsourced contracts by effectively reducing the retained organisation and servicing management information systems, contract payments, service level agreement monitoring and change control services.

- A move towards a requirement for project-specific, one-off outsourcing rather than lengthy contracts. This will see the rise of agile suppliers able to offer short-term, business-specific solutions.

- Fees for outsourced services are likely to become much more volume-price sensitive as businesses move towards requiring flexible volume based pricing from their suppliers. This way they can increasingly control costs rather than have volume guarantees or high fixed-fees irrespective of volume.

- The decline of multi-sourcing owing to the expense involved in monitoring a multitude of suppliers.

- UK IT suppliers may increasingly offshore their own software development requirements so that they can concentrate on innovation and delivering solutions as well as creating powerful sales capabilities.

The challenge for the IT sector will be to respond quickly to changing demands and an increasingly global marketplace. For agile businesses the rewards could be great.

Andrew Rigby is a partner at Brodies LLP

Read more on IT outsourcing