TPI INDEX REPORT: Q3 2003

A REPORT ON THE EUROPEAN SOURCING MARKET

10TH OCTOBER 2003

CONTENTSPAGE

  1. FOREWORD
  2. Q3 2003 - HEADLINES
  3. MARKET OVERVIEW
  4. DEALS IN THE PIPELINE
  5. BPO TRANSACTIONS
  6. SERVICE PROVIDERS
  7. LOOKING FORWARD - Q4 2003 AND BEYOND
  8. OUTSOURCING DEALS BY INDUSTRY
  9. SPLIT IN BPO DEALS - RISE OF F&A
  10. GEOGRAPHIC SPLIT
  11. CONCLUSIONS
  12. TPI PROFILE

1.FOREWORD

This is the third quarterly TPI European Outsourcing Index report. TPI’s objective for producing it, together with the accompanying conference call, is to provide greater insight into the global outsourcing marketplace for those who want a balanced and informed view of the market.

TPI is an advisory services company that serves only the buy-side of outsourcing contracts. Is has not, does not and will not represent the service providers in this industry in an outsourcing transaction. TPI’s position as the largest and most successful provider of outsourcing advisory services means it is well-positioned to gauge the state of the outsourcing market.

For confidentiality reasons, this report does not include discussion of specific clients and sourcing transactions. It includes expressions of TPI’s opinion, using data both from TPI and the market. They are also based on its experience and understanding of client attitudes and preferences as they relate to the value of outsourcing and the capabilities of the service providers in this industry.

Public sector outsourcing is not included in this report.

If you would like further information about TPI, or would like to join future TPI Index calls and reports, please contact:

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2. Q3 2003 - HEADLINES

Large outsourcing contract awards

The third quarter contract awards in the global marketplace continue to show 2003 to be on par with 2002 for deals with a total contract value (TCV) of €200M or more. The trend in 2003 has been away from ‘mega-deals’ - contracts of more than €1 billion - and towards contracts of smaller value. TPI continues to predict 2003’s full-year TCV to be slightly below last year’s level for the larger contracts.

Year to date, there have been 54 deals with TCV greater than €200M, up six percent on 2002’s 51 deals through the same period. Year-to-date, the value on those contracts is up about 10 percent from 2002: €37B in 2003 versus €34B last year. TPI market share for deals greater than €200M, measured by TCV awarded, grew from 39 percent in 2002 to 45 percent YTD in 2003.

The fourth quarter of 2003 is unlikely to be as robust as the fourth quarter of 2002 for mega deals. €20 billion worth of deals were announced in Q4 of 2002. TPI has not seen the same number of mega-deals active in today’s market and concludes a relatively flat volume of TCV to be awarded year-over-year.

Larger contracts - Europe vs US

The larger contracts awarded year-to-date in the Americas are tracking slightly behind 2002 levels in number and dollar value. But, for the year so far, Europe has surpassed 2002’s full-year levels in both number of contracts and TCV. At the end of Q3, the number of contracts signed in Europe of more than €200M is up 83 percent on 2002 and the TCV is up 148 percent. Larger outsourcing contracts are more prevalent in Europe than ever before.

Mid-sized deals - €50 million upwards

In Q3 2003, there were 52 transactions signed globally of this size. These 52 deals were valued at €13.7B. Year-to-date, the transactions of this size number 145 deals valued at €46 billion, for an average deal size of €317 million. This compares with the first three quarters of 2002 in which there were 133 such transactions valued at €42 billion, yielding an almost-identical average contract value of €316 million. There has been in the region of a 10 percent increase in both number and value of these deals. In Europe, there is growth of around 5 percent in the number of contracts over €50 million (44 year-to-date in 2003 as opposed to 42 in 2002). However the TCV in this category has increased by 87 percent on the same period last year (from €8.4 billion in 2002 up to €15 billion in 2003). The average deal sizes for contracts over €50M in Europe are up 39 percent over last year to €442 million.

While there is not the volume of mega-deals this year seen in 2002; there is a marked increase in deal sizes in these mid-size contracts. It seems that the market for larger contracts has been a highlight of the outsourcing market in Europe thus far in 2003. Because of this growth and the changing demographics of the contract opportunities, there is a greater diversity of successful service providers.

BPO transactions

TPI has recorded 34 BPO contracts in the mid-sized category announced so far this year, valued at a total of €8 billion – for an average deal size of €235 million. This compares with 38 comparable contracts last year through Q3 valued at €12 billion – for an average of €316 million. Globally, there has been a 26 percent decrease in the average euro value awarded in BPO contracts this year. The picture in Europe is somewhat different. BPO deal sizes in Europe are in line with the overall upward trend in the region, with average BPO deals valued at €300 million as opposed to an average value of €193 million in 2002. Clearly, Europe is bucking the trend.

Outside Europe, BPO relationships are becoming more focused and narrowly-defined. The market in Europe, however, has retained a wider scope as companies look to BPO to help them compete more aggressively in the global stage. TPI has advised on 31 percent of the global BPO TCV year to date.

3. MARKET OVERVIEW

Pricing trends

TPI is frequently asked by it’s clients for advice on utility pricing or on-demand services.

TPI’s view is that a well-engineered sourcing strategy accommodates variability in resource consumption as a cornerstone of its design. Achieving pay-as-you-go variability is one of the principle reasons that clients choose to outsource.

The business models related to variable pricing and variable consumption have been proven through outsourcing relationships during the past 10 years or more.

Recently, many of the service providers have made considerable investments in technologies to better allocate capacity in response to demand. They have the ability to bring mainframe computing capacity, storage or networking resources on-line in response to surges in customer demand. TPI applauds the industry for increasing the flexibility in these services.

However, clients often think that ‘fully variable’ services allow for no minimum commitments and virtually infinite capacity.

TPI has not seen any meaningful pricing or business terms offered in the marketplace for IT infrastructure services that would indicate significant change. While improved technology capabilities may be available to help manage the infrastructure, those capabilities are not yet appearing as commercial business offerings.

On the other hand, the trend towards business process outsourcing is revealing the reality of the ‘utility’ potential. The nature of a BPO services agreement is fundamentally different in many ways than an IT infrastructure relationship. One of the more considerable differences is the focus on outcome of a BPO relationship. Clients are purchasing end-services, priced on a transactional or business-result basis. They are indifferent to the underlying infrastructure required to deliver those services.

So, the bottom line is a mixed message. The promise of ‘on demand’ computing is certainly relevant to clients who are seeking to increase their variability, but they might need to approach the topic from the perspective of business processes rather than IT infrastructure.

The service providers that are making investments to align capacity with demand are certainly well-positioned to succeed in this market, but they will do so with an outcome-focus to their pricing and business terms.

Furthermore, the BPO providers that will offer the most efficient and attractively-priced offerings will do well at managing the underlying infrastructure.

The tempo in the market appears to be picking up pace, with several new initiatives recently begun. Demand is steady for ITO and picking up steam for BPO. Utility computing is an enabler, but the buyer must be able to separate the hype from the business value.

4.DEALS IN THE PIPELINE

During Q3, TPI advised on 14 transactions that closed with a contract signing valued at €4B which was eight percent greater than predicted in Q2.

Looking forward, it is likely that a little over €8.5 billion will be awarded in the next 90 days. After that, TPI is working on deals with over €3 billion likely for award in the first two quarters of 2004, although there are a few very sizable transactions underway which are not yet to the stage of assigning a TCV amount in the pipeline. The first quarter is traditionally a light period for large contract awards, and this level of active pipeline reflects the customary seasonality associated with outstanding transactions. New pipeline activity often increases in Q1.

TPI presently has just over €17 billion in active transactions at the end of Q3. These comprise 51 distinct transactions averaging over €330M each.

In Q2, TPI had six mega-deals in the pipeline, compared to four in Q3. Differences in pipeline value between Q3 and Q2 are the result of relatively few mega-deals in the pipeline and an ever increasing proportion of deals with TCV less than €500 million. Almost 79 percent of active transactions are targeting a TCV of less than €500 million. This is up from 64 percent in Q2 and 47 percent in Q1. The trend in the global marketplace is clearly towards smaller-valued deals as BPO continues to impact distribution towards the lower end of TCV. In general, BPO transactions average about half the TCV of IT transactions. This is not the situation in Europe where, although there are few mega-deals, the trend is clearly showing an increase in average contract value across both ITO and BPO deals.

5. BPO TRANSACTIONS

Globally, 23 percent of active engagements are BPO-related assignments. Of these, 38 percent are European deals. TPI has advised on seven BPO contract awards that were valued at €2.5 billion as at September 2003. This excludes the recently-announced large BPO deal with Gateway Computer. TPI’s BPO business is on track to grow over 120 percent year-on- year and represents the fastest-growing part of its business.

The UK has a 57 percent share of European BPO deals signed industry-wide of more than €50 million. CRM deals made up 43 percent of the total European BPO deals signed this year, with HR deals finance & administration (F&A) related. There is a clear shift away from front office/call centre BPO towards the outsourcing of core internal services such as HR and Accounting. Another trend is the wider dispersion of deals across Continental Europe.

Globally, on BPO contracts signed industry-wide of more than €50M, Accenture has a 27 percent market share of awards, year-to-date. Accenture is out-performing all other providers in BPO bookings. Other non-ITO oriented service providers have won 63 percent of the contract value, speaking to the diversification of this market.

6. SERVICE PROVIDERS

On a global basis, the ‘big six’ (IBM, CSC, EDS, Accenture, ACS, and HP) are continually at the top of the list on many of the deals that we advise on. Please note that TPI negotiates on behalf of clients with many different service providers - too many to list here - however, these six are consistently in its top 10 monthly rankings for deal activity. So far in 2003, TPI has supported 37 contract awards to 19 different service providers.

Significant milestones

  • IBM’s recent win of the P&G Employee Services contract is a potential market-shaping event because of the global scope of the transitioned services
  • CSC’s recent successes in Europe appear to be rippling towards the U.S. as measured by the level of outsourcing bookings they have recognized so far in 2003. CSC is also leveraging its financial services product portfolio for transforming client operations
  • EDS continues to compete well in the global market, is retaining their large customer base and possesses a strong reputation in the transactional outsourcing markets
  • Accenture has leveraged its corporate relationships for sole source opportunities and is among the best at positioning transformational outsourcing offerings for HR and F&A services that make relevant an extensive offshore capability
  • ACS, though largely US based, is competing on it’s foundation of offshore and transaction-intensive excellence – all focused on the BPO marketplace
  • HP is quickly assimilating the P&G infrastructure operations to extend its reach and position itself as a top-tier competitor.

Other vendors (those not in the ‘big six’) have won 36 percent of TPI’s contracts to date in 2003 and almost 11 percent of the TPI-advised TCV. This compares to 2002, when these other companies won only 13 percent of TPI-advised contracts and only 2.5 percent of the associated TCV. Clients are reaching beyond the traditional IT-oriented providers to engage a much broader cross-section of the sourcing industry.

Perhaps symptomatic of the industry at large, the average deal size of many service providers has decreased from 2002 to 2003. Most notably, IBM has seen its average deal size for industry-wide transactions drop over 50 percent, from €962 million in 2002 to €435 million in 2003. Deal size for EDS has dropped 34 percent from €338 million in 2002 to €223 million in 2003. Part of this drop can be explained by the absence of the mega-deals that were prevalent in 2002 but not here in 2003. However, some of the drop is attributed to the fact that, with the exception of the European market, average deal sizes are simply smaller.

Pipeline for the service providers

Pipeline values for service providers change on a monthly basis as contracts are awarded, deferred or TPI is no longer involved in the sourcing process. Since Q2, almost all of the ‘big six’ have seen a decline in their pipeline by value, as a result of a smaller overall pipeline of business.

However, CSC and ACS have increased in the number (as opposed to value) of deals, and IBM and EDS have declined only slightly.

IBM leads all service providers competing for 37 percent of TPI transactions and 38 percent of the dollar value of our pipeline. CSC and EDS run a close second and third, respectively. TPI has noted some movement into the pipeline from a few of the European based suppliers, with CGEY and XChanging competing for four deals (three and one respectively) valued at a total of €900 million.

Several of the Big Six providers are in a strong position to increase their BPO pipelines. Both IBM and Accenture are involved in more than 54 percent of TPI’s BPO transactions. Accenture is involved in more than 51 percent of the dollar value while IBM comes in at almost 48 percent. ACS and EDS are also competing for large parts of TPI’s forthcoming BPO deals.

The BPO market is much more fragmented than the more mature ITO market. There is much more competition in this market - with 18 unique providers competing for TPI transactions, compared to 12 at the end of Q2.

7. LOOKING FORWARD - Q4 2003 AND BEYOND

While TPI expects a reasonably robust fourth quarter, its does not envisage the same level of contract announcements seen in Q4 2002. This results from the lower number and smaller size of mega-deals. The first quarter should hold true to form and be a relatively light quarter for announcements.

During the summer months there was a great deal of indecision and hesitancy by clients, resulting in delayed contract start dates, and transactions being put on hold, or even cancelled. Therefore, TPI does not anticipate announcements of significant euro value early next year. In the past few weeks, there has been increased activity with a number of clients deciding to move ahead on large transactions or assessments (€200 million in TCV or greater). This could positively impact the second quarter of 2004.

8. OUTSOURCING DEALS BY INDUSTRY

Industry-wide, for contracts greater than €50 million, financial services, telecommunications and manufacturing remain the most prevalent buyers of outsourcing services. However, the TCV to date in 2003 for these three leading market sectors has shown some volatility: financial services has dropped significantly while manufacturing has expanded significantly, and telecommunications has remained relatively flat.

There is a similar picture in Europe where financial services, manufacturing and telecommunications are the most active in terms of numbers of contracts signed over €50 million in 2003.

BPO contracts are being signed most often in the same industries. In this most recent quarter, over 90 percent of all BPO contracts of more than €50 million were signed with clients in these verticals. Telecom has dropped significantly from 2002 levels where this vertical had represented over 40 percent of the TCV - to 2003 levels where it has slightly more than 11 percent of the market share. Energy, on the other hand, has grown from 6 percent to 28 percent of the global TCV awards.

In TPI’s deal pipeline - which serves as a six to eight-month leading indicator - six out of 13 active BPO transactions are in the manufacturing sector. Financial services still has a presence in this sector as over 30 percent of current BPO transactions involve financial services companies.