Points of View

Service providers need to prepare for the impact of COVID-19 on the services market

May 5, 2020 Jamie Snowdon

One of the words that you will hear the most when people discuss any market and COVID-19 is “uncertainty”—uncertainty about the scale of the impact, and uncertainty as a killer of market confidence and market performance. The one thing that isn’t uncertain is the fact that COVID-19 will impact the market—the only debate is the scale and the timeframe.

 

It’s hard for a market forecaster to get the balance right when making changes due to a financial or worldwide event, particularly something as serious as COVID-19. We don’t want to be the grim reaper for the market, but we do want to get ahead of it and let the numbers lead us.

 

Project-based services (professional services and integration) react quickly

 

The areas impacted the most in the shortest term tend to be project-based services like consulting and systems integration. These markets operate over short periods with short contracts. It also takes time for these markets to react to changes in conditions. However, these markets need to keep their work pipelines primed, or they will burn through their backlogs and staff will be sitting on the bench instead of working and earning money.

 

Typically, in periods of recession project work tends to be more heavily scrutinized, and ROI needs to be much clearer from the beginning, with financial and cost control taking front and center stage for the foreseeable future. Larger project work is often canceled or split into smaller, more manageable chunks, and clients generally require more discussion about alternative pricing structures and guarantees of ROI.

 

How operational services (outsourcing and managed services) react more slowly

 

A popular myth in the sourcing world is that a poor economic climate leads directly to outsourcing; however, this is just not the case. During the 2008 recession, outsourcing growth took a significant hit, and many organizations shied away from radical business decisions.

 

During recessions, organizations generally look for tangible opportunities to provide the short-term cost savings necessary to help navigate an economic crisis, namely layoffs, travel freezes, office closures, and divesting of unprofitable assets. During the great recession, many organizations delayed long-term commitments for up to four or five years after the crisis.

 

However, operational services like managed services and support services are insulated somewhat from extreme spikes in spending in both directions; the market reacts much like a supertanker, and it takes a long time to change speeds.

 

The current crisis may see work volume increase for many of these contracts in the short term as companies need to use service partners to bolster home working arrangements, although in many cases, this will lead to additional discretionary spending.

 

Distilling the best information into scenarios

 

With these general factors  in mind—we are approaching any potential changes to the market with four scenarios, shown in Exhibit 1. We are trying to use what happened in the past to help us view the changes going on now and then apply that knowledge to current market conditions and predict likely impacts.

 

Exhibit 1: There are four market growth scenarios post-COVID-19 

Source: HFS Research April 6, 2020

 

In Exhibit 1, we start with scenarios 0 and 1, where the impact is similar to a small, short-term, “normal” recession—much like the early 1980s and 1990s recessions. In these scenarios, the impact is fairly short term; it affects a couple of quarters badly, and then the market comes back after four to six quarters. There is a decline in new business for professional services, but most existing deals will proceed. Delays in deal signings, with deferments to Q1 2021, impact operational services. The difference between scenarios 0 and 1 is that scenario 1 experiences a more serious impact on discretionary spending.

 

Scenario 2 is like a bad recession. Although we’ve made the market bounce back a bit more quickly given the (hopefully) relatively shorter nature of this. Major decision-making halts. There is a drastic decline in new deals for professional services. Discretionary spending in operational deals slows, and deal volumes fall, impacting revenue as some industries slow operations.

 

Now, in scenario 3, business is very much not as usual.  A significant amount of work cannot be completed due to local lockdowns and social distancing. The impact on professional services means more deals are delayed and results in a longer recovery—a more costly and longer overall impact. The impact on operational services is longer delays, and the net effect impacts current contracts and signings for the foreseeable future.

 

The impact on the services market likely to be large regardless of scenario

 

Data from our recent survey shows that enterprises’ revenues are down as much as 7.6%, and service providers have experienced a 3.3% drop, on average. It’s interesting that consultants and advisors are more pessimistic, expecting around a 15% drop. What else have we seen? Well, Accenture’s published results to the end of February showed YoY growth of 7%, but now the company is predicting -2% to 2% growth for the next quarter considering the virus’s impact—this is a delta of between 5 and 9 percentage points. Plus, we’ve seen new economic forecasts with Q2 GDP growth for European countries like France, Germany, and Italy at -10%, the UK at -9%, and the US at -6%.

 

We think that the data puts our current situation somewhere between scenarios 1 and 2, but there is potential to surpass scenario 2. Particularly with an extended period of lock down in the US and Western Europe with longer term recessionary impacts.

 

You can see the impact of the scenarios on the services market in Exhibit 2.

 

 

Exhibit 2. Markets will be impacted until 2022

 

COVID-19 IT and Business Services Growth Scenarios

 

 

Source: HFS Research April, 2020

 

Our original market growth forecast hovered around 5%. Scenario 0 halves the rate for 2020 to 2.3%. For scenario 1, we expect a small decline at -1.5% for 2020 then -2.4% in 2021. For scenario 2, we expect -6.1% growth in 2020 and -8% in 2021. For scenario 3, we expect -9.2% growth in 2020 and -12.4% in 2021.

 

The Bottom Line: Ongoing uncertainty is certain, which damages the large project-based and operational services markets.

 

The current issue is that we still don’t know how long this crisis will last and the depth of its short-term impact. The April and May results season, when we see Q1 results of some of the main players, will be interesting. Although the results are unlikely to directly show major impacts, we should see more guidance forecasts from service providers, which should give us a better indication of the road ahead. However, the recent lack of guidance from TCS, Infosys, and Wipro is likely to make the uncertainty worse.