Information Services Group, Inc. (III) Earnings Call Transcript & Summary

Good day, and welcome to the Fourth Quarter 2021 ISG Global Index Presentation. I'm Kathy Rudy, ISG Index co-host and Chief Data and Analytics Officer. It's kickoff time, and I'd like to turn the presentation over to the Index host this quarter, Bryan Bergin of Cowen and Company.

Thank you, Kathy. Hi, all. Happy New Year. I'm Bryan Bergin, Cowen Services, HCM and Automation analyst, and I'm very pleased to be hosting the Global ISG Index call. ISG's role as a top adviser and influencer in global sourcing offers a unique view of the state of the outsourcing and SaaS markets. This is the 77th quarterly call. ISG has been hosting this event for nearly 20 years, and it's evolved with the industry. Its position in enterprise contracting of tech services and software enables it to key in on the leading trends, and this is often useful ahead of the quarterly earnings season. The format of the call will be a presentation of 4Q contracting data and key trends into 2022 by Steve, Kathy, Stanton and Christian. And at the end, it will be open for audience Q&A. I'll now pass it back to Kathy Rudy, ISG's Chief Data and Analytics Officer. Kathy?

Thank you, Bryan. We've done something a little different as you can see, we're here together live. These are some special circumstances, and it's not likely to happen anytime soon, but we are really excited about the change up. Our vaccinated and boosted team includes Steve Hall, Partner and Global Leader for the ISG Index; Stanton Jones, Research Director and Principal Analyst. And we're also joined by Christian Decker, ISG Partner and Smart Manufacturing in EMEA. This is our 77th quarterly index call, closing in on 20 years of market analysis, it's almost hard to believe. Based on feedback from you, though, we've added some new sections to the call. This quarter, we've added insights on pricing, deal size, recent flurry of mergers and acquisitions. Plus Christian will discuss key trends in manufacturing and what they mean to our clients. As a reminder, we have a Q&A, but what you'll need to do is use the chat box to the right side of the slide. Type your question in and then click on the up arrow to send it to us. Steve, let's get started. What are the main takeaways for the quarter?

Great. Thanks, Kathy. 2021 was a record year for the industry. We saw a strong growth in managed services and as-a-services space with 3 key thoughts. First, we saw record high ACV in managed services and in the ADM space. ADM accounted for almost 65% of the total ACV awarded in the ITO sector this quarter. The engineering segment had nearly 3x more ACV than in any prior year. But the as-a-service market almost also had great growth with almost $14 billion in ACV than 2020. Both SaaS and IaaS accounted for more ACV than ever, and SaaS had the highest annual growth rate yet. BFSI reached new highs in both managed services and as-a-service, and each region had the most ACV awarded to date. One of the findings though, was the fourth quarter showed signs of a slowdown when compared to prior quarters. The year-over-year compares against the COVID impacted 4Q '20 were quite positive, but quarter-over-quarter compares against the recovering market in 3Q '21 or less so. The global combined market ACV advanced only 1% during this period, and the global managed services was flat. We remain bullish on the growth of the overall market. The tailwinds that continue to drive the market are accelerating, but the combined headwinds with the pandemic, inflation, supply chain disruptions and the great resignation will continue to impact market growth. Now let's take a look at the global market trends. The global combined market ACV of both managed services and as-a-service reached nearly $23 billion this quarter. That's over 30% higher than the end of 2020 and 48% over 4Q 2019. The combined market ACV for the full year was more than $84 billion, an annual growth rate of 29% over 2020 and a 41% rise over pre-pandemic 2019, ending the year with 2 very strong quarters put the annual growth rate higher than we've ever seen since we started tracking this metric in 2014. And managed services logged its third consecutive quarter of more than $8 billion in ACV and the number of deals exceeded 500 for the fourth consecutive quarter. 7 mega deals were awarded globally in this quarter. For the full year, managed services hit nearly $33 billion in ACV and its year-over-year growth rate of 16% was the highest since 2014. It rose 14% even against the 2019 numbers. As-a-service ACV this quarter exceeded $14 billion, only the second time it's done this since we started tracking it. The segment has grown steadily every quarter this year. Its 46% year-over-year growth rate was just a bit off last quarter's growth rate. Even so, the last 3 quarters of 2021 added up to a sustained high rate that is the best since 2018. For the full year, as-a-service ACV topped $51 billion, a 38% increase over 2020 and a stunning 66% over 2019. As-a-service continues to take on a greater market share and now accounts for 61% of the combined market. There are a number of headwinds and tailwinds that drove the market this year. Headwinds included pricing pressures and staffing, while M&A and robust deal flow provided positive tailwinds. Kathy and Stanton are now going to talk about some of these tailwinds and headwinds.

Thanks, Steve. We've got a lot of questions about rates and inflation and management of prices on contracts. We wanted to give you some of our insights on how we're seeing wage inflation impact the market and in what way. It's very important that we talk about it in 2 different ways. First is through the managed services contracts. Those are the contracts from a specific set of services as you all know. And it's managed monthly versus project work, which is typically handled as T&M or time and materials. Thinking about it in this way will really help us set the stage. So on the managed services side, we're seeing rates hold steady on existing contracts. There's not a lot of renegotiation or trying to open a contract and renegotiate those rates like we saw in the early days of COVID. Additionally, expect minimal increases on new contracts for similar scope. In the managed services arena, our data really shows that there hasn't been a big jump in any of the rates or prices in this area. And in some areas, we're actually seeing the reverse. We're seeing it going in a different direction. Now let's talk about how the providers are reacting to this. What they're doing is they're ramping up more junior resources. So they're instituting intensive training programs on campus, 6 to 9 months for freshers right out of school, so they can get them up and running on managed services deals. In addition, we're rolling out automation, as you well know, and driving efficiencies through technologies. So these 3 things combined are really helping to hold down the pricing pressure on managed service. Let's look at the T&M side. We're seeing rate increases of between 4% and 7% for highly in-demand skills. These are senior people, adept at new technology with strong digital transformation skill sets that enterprises really don't have on staff and can't ramp up right away. We're also seeing providers doing something around blended rates. So they're creating something called an average daily rate or effective rate for a day, and that's a pricing mechanism used to avoid having to haggle over those individual rates. It's a bundle of skills or technologies for an effective day rate, and this helps them really balance their staffing pyramid for maximum offshore capability, but retaining the quality and that really, in effect, helps them maintain their margins. We're seeing that projects are often backloaded for profitability. As deals shrink, they're really putting everything forward into the first years to get the clients sticky, and it's giving them the ability to stick with them, embed with the client and help them manage through their large transformations. I wanted to close out with a few other things we're observing in the market. One is the overall context of margins and things that service providers are maybe doing similar to other enterprises and organizations. They're really looking at all their line items across the spend areas and aggressively managing that discretionary spend. They're also reaping some benefits from reduced nonreimbursable travel expenses and that really helps them manage the overall deal and the cost of sale. There's something else that we're keeping an eye on, and that's COLA clause and contracts. We're actually seeing a reduction in the number of contracts that include a COLA clause. Stanton and the team have really been watching this closely. They're building some analysis. And later this month, they're going to release research related to COLA that you can have access to. We're also seeing some impact on both sides from currency or FX. And this could be an upside or a downside, and that's something that we're seeing in combination with COLA. So just to put these considerations in your mind and take them into account, when you're thinking about pricing, what impact that has on the market. Stanton's now going to give us a little bit more on attrition and how that relates to pricing.

Thanks, Kathy. We did want to address one of the biggest challenges in our industry right now, and that's attrition. So we've talked at length about the great resignation and the challenge that we're all having with identifying and retaining and up-skilling digital talent. So as you can see here, attrition levels are near or at all-time highs. Now attrition at 20% isn't a huge problem 2 years ago, but with demand so strong today, it's creating a lot of pressure on providers and creating challenges for enterprises as they look to accelerate their digital transformation. Providers are using lots of tools to mitigate this. In the short term, they're using increased use of subcontractors and more lateral hiring. That helps to meet a short-term need, but of course, those approaches are more expensive. So providers are also doing a lot more midyear salary adjustments. As Kathy talked about providers are mass hiring at a campus level to meet expected demand. And they're automating every opportunity they can. But those approaches, of course, are going to take a few quarters to pay dividends in our view. All that said, we don't see this as a multiyear challenge. We think that the benefits from hiring and training will start to kick in this year. And we should largely be over this hump in the next 2 to 3 quarters. So we've talked a lot about some of the potential headwinds in our market, pricing pressure and rising attrition. So now we're going to turn to some of the opportunities that we see. And the first one is really around the idea of these smaller deals. So while mega deals get a lot of headlines, it's really the smaller deals that form the backbone of our industry. As you can see here, over 80% of the managed services awards are under $20 million ACV. There's actually a slight decline in this band in 2021. In 2020, that was actually 85%. And as I mentioned, while mega deals are still big and critically important to our industry, only 12% of broader market ACV comes from mega deals, and that's actually down from 20% in 2015. And this is happening because enterprises want to move faster than ever before. They're breaking down transformation-related work into smaller chunks, oftentimes in line with products that can get done faster, so we think that smaller profile is here to stay. We think that's also creating opportunity for midsized providers, and they're increasingly being engaged by bigger providers as well. The second opportunity we want to focus on is M&A-fueled growth. 2021 has been a record year for M&A activity. As you can see here, we smashed all kinds of records this year, both in number of transactions, which was up 47%; and in the value, which was up 63% year-over-year. So a few reasons for this. Companies tightened up their spending during the pandemic. So there is more capital available. Interest rates were low in 2021. So those 2 things, combined with the really strong demand environment or all things digital is leading to the record-setting activity you can see here. As you can see on the right-hand side of the chart, the 2 biggest areas, buyers targeted in 2021 are IT services and engineering. In terms of who is doing the buying in 2021, Accenture, Deloitte, IBM, Atos and Tech Mahindra were the most active on the M&A front. And a final note on M&A. In 2021, we saw a lot of interest from private equity. There were $7 billion-plus deals in 2021. For example, Advent International acquired digital engineering firm Encora. KKR acquired ISG leaderboard provider Ensono and I Squared Capital acquired KIO Networks, Mexico's largest data center operator. And of course, Baring Private Equity has been particularly active in our sector of late. So we think PE firms will continue to focus on larger transactions. We also think they'll continue to hold their portfolio companies longer in anticipation of a larger potential IPO. And we also think providers will continue to aggressively use M&A as a tool to round out capabilities and to penetrate further into existing clients. Steve, back over to you for more on managed services.

Kathy and Stanton, thanks. Great sessions on the key trends that are impacting. So now let's take a look and break down the full year performance by function. Starting with ITO, which posted a $25 billion in ACV in 2021 with an annual growth rate of more than 12%, the highest that we've seen in 7 years. It rose 16% from 2019. So a record 1,560 contracts were signed globally. Applications continue to drive the ITO market, accounting for 65% of the ACV. The ADM ACV of $14 billion was up 40% over 2020. Infrastructure, on the other hand, dropped nearly 11% to its lowest ACV since 2013, clearly associated with cloud adoption. BPO posted nearly $8 billion in ACV for 2021, a growth rate of 31%, which has never been seen since 2012. BPO contracting activity increased 32% over 2020 and 6% over 2019. The strongest growth came in the Asia Pacific markets, up 57%; followed by EMEA at 45%; and the Americas trailed a 22% annual growth rate. The ER&D ACV of nearly $2 billion marks a 170% increase over 2020. Industry-specific BPO ended the year flat, F&A remained in positive numbers and contact centers recovering from its low in 2020. Facilities management is also on the upswing, but still hasn't recovered from its pre-pandemic levels. Now if we take a look at the as-a-service sector, it had an exceptional year. Every quarter hit record new highs. Infrastructure as a Service generated ACV of $38 billion for the full year. This was up 40% over 2020 and up 85% compared to 2019. The only concern was the sequential growth of the last -- of IaaS in Q4. It was only up 3% over Q3. But again, we had an exceptionally strong Q3 for IaaS. By region, Asia Pacific led the way with infrastructure growth at almost 48%; EMEA saw 44% growth; and the Americas was up 34%. The big 3 U.S. hyperscalers AWS, Azure and Google have outperformed the overall infrastructure market this year. AWS and Microsoft had an annual growth rate of 45%, and Google grew at 31%. These 3 combined for almost 75% of the overall market and have grown over 40% since 2020. So what's happening here is the competition in IaaS market is actually consolidating. That said, we think this growth is sustainable as most enterprises are still in the very early innings of their digital transformation. Software-as-a-Service ACV was up 31% over 2020, primarily on the strength of the final 2 quarters, though of 2021. And finally, in contracting to the shrinking competition in the IaaS market, competition in the SaaS sector is growing, fueled by the onset of the pandemic. Smaller SaaS firms have actually grown their ACV faster than the top 10 SaaS firms. Now let's take a look at the global leaderboard board. The regional listings are at the back of the deck which can be downloaded from the ISG website. Typically, our leaderboard list has a fair amount of turnover from quarter-to-quarter, especially among the smaller firms are breakthrough and booming categories. But this time, each group remained fairly static, so we'll highlight a few firms with some interesting actions. In The building 15, Wipro signed a contract with Aggreko. Tech Mahindra was selected by Asahi Europe & International to migrate applications to the cloud and consolidate vendors. And among the as-a-service firms, ServiceNow inked deals with clients, Stanley Black & Decker, Uber, Honeywell and Fujitsu. On the breakthrough list, Shopify had success in the retail space by signing notable contracts with French beauty retailer L'Occitane; Swiss computer manufacturer, Logitech; and Australian retailer Woolworths. And cybersecurity provider HubSpot joined The Booming 15 Group. Kathy, let's take a look at the regions now.

The Americas, despite headwinds is on a roll year-on-year. The combined market ACV for the fourth quarter was $11.5 billion, an increase of 52% compared to the end of 2020. For the full year, the combined market finished up 27% compared to 2020 and 2019. Managed services saw back-to-back quarters over $4 billion. Still, the $4.2 billion in ACV in the fourth quarter was 10% below that of the prior quarter. For the full year though, the Americas has the highest ACV ever of more than $16 billion. That marks a 19% increase from 2020 and a 17% rise from 2020 -- 2019. The number of awards exceeded 1,000 for the first time, and this included 10 mega deals. As-a-service, which had its first $5 billion quarter at the beginning of the year ended by breaking through the $7 billion mark in the fourth quarter. It posted a 53% year-on-year gain, the best ever. For the full year, ACV of more than $25 billion reflected a 32% rise over 2020 and 53% increase from 2019. As-a-service now accounts for 61% of the combined market ACV in the Americas. All right. Let's look at the EMEA, Steve.

Yes. It's amazing to see the numbers in the Americas, Kathy, really strong growth. EMEA is really on solid upward trajectory. The combined market ACV has stayed above $5 billion per quarter since mid-2020, including 4 consecutive $6 billion quarters. And this quarter, we topped $7 billion. But that pace is slowing a little bit as we've seen in other regions, 4Q's 2021 year-over-year growth rate was slower. It was only 9% in EMEA, and that's the lowest of any quarter during the year. For the full year, EMEA's combined market rose 23% over 2020, the best growth rate since we began tracking this metric again since 2014. The managed services space posted a fifth consecutive quarter of ACV over $3.4 billion. While its year-over-year performance in the fourth quarter dropped 16%. Remember that 4Q '20 had some very large mega deals which included the Daimler deal that we talked about the last several quarters. We've really seen an unprecedented level of sustained contracting activity though in Europe. The past 4 quarters have each signed at least 200 awards. And the $14 billion in ACV for the full year was 11% higher than 2020 and 12% higher than even 2019. And we saw 9 mega deals awarded in for the whole year in 2020 just in Europe. So most of the regions saw sizable annual increases, except for 2 of the larger markets. The U.K. was up just 2% for the prior year and DACH fell by 29%. DACH was impacted by difficult compare so, again, the Daimler deal that was awarded in Q4. But DACH also was impacted by supply chain disruption and really a slowdown in global consumer spend, which led to an extension of existing scope and a pause in really the larger transformation deals. Interesting though, France, the Middle East and the Eastern Europe all saw record highs. The as-a-service market ended the year with back-to-back quarters over $3 billion. The $3.6 billion in ACV in the fourth quarter was up 55% year-over-year, but just 5% from the prior quarter. For the full year, as-a-service generated over $12 billion in up 41% from the prior year and 61% from 2019. The as-a-service now accounts for nearly 48% of the combined market ACV in EMEA. So really getting close to what we're seeing in the Americas as well. So Kathy, what's happening in Asia Pacific?

All right. Thanks, Steve. Let's round out the regions with Asia Pacific. For the full year, Asia Pacific combined market ACV was up 44% versus 2020 and 74% over 2019. That's the strongest growth since we began tracking it in 2014. Managed services ACV in the quarter came in just shy of $1 billion for a 43% or year-on-year gain and 50% quarter-on-quarter. Two of the largest quarters reported in the history of the Index were in 2021. So just keep that in mind for some perspective. For the full year, managed services saw nearly $3 billion in ACV, a 32% rise since 2020. And Asia Pacific had 24 awards over $30 million this year. That's the most since 2014. This is a significant jump. Each of the major geographies were also up in 2021. Japan, ANZ and China each posted annual gains greater than 30%. We're really seeing a lot of activity in Asia Pacific. If we look at the as-a-service ACV, it surpassed $3 billion in the fourth quarter as it did in the third quarter. The year-on-year increase was 28% over 2020. Now compared to the prior quarter, though, the Q4 2021, this was a decline of 7%. This represents a slowdown given that prior quarter-on-quarter compares posted gains upwards of 50%. Let's find some perspective on this. The market slowing on a sequential basis was mainly confined to China in the Infrastructure-as-a-Service segment. To illustrate, if we were to strip out China, the negative impact on the fourth quarter, the rest of Asia Infrastructure-as-a-Service actually grew 68% year-on-year and 18% quarter-on-quarter. For the full year, the $13 billion in as-a-service ACV was 47% higher than 2020 and 105% over 2019, which is very substantial. As-a-service now accounts for 82% of the combined market in Asia Pacific, the highest ratio of any of the regions. This is going to wrap up our regions, and now Steve is going to give you some of our global industry trends.

So if we look at the global industry trends, BFSI has been particularly active this year with nearly $18 billion in combined market ACV. That translates to an annual growth rate of over 30% for the 2 sectors of managed services and as-a-service. BFSI is a key inflection point as organizations look to really lower the total cost of ownership, improve customer experience through AI and analytics, and really serve customers faster. The as-a-service ACV in BFSI had new highs as well. $8.4 billion, up nearly 38% against 2020. And the as-a-service market saw its fastest growth rate in Asia Pacific with 74%; followed by Europe at 38%; and the Americas at 32%. The as-a-service comprises 47% of the combined market ACV now. So we expect the largest enterprises in BFSI to continue to grow maybe at a more moderate pace. So I think we're going to call it just under 4.5% in 2022, but we'll still see robust spend in that industry. So manufacturing is our focus area for this quarter. The combined market ACV reached nearly $14 billion, a 16% gain over 2020 and a 40% increase from 2019. Managed services did fall back slightly to a $5.4 billion, down 11% from 2020, but up 21% from 2019. I think we'll talk a little bit about that in our special today as well. The as-a-service on the other hand, accrued $8.4 billion in ACV, $2.5 billion more than 2020. The as-a-service now makes up 61% of the combined market ACV. Now over to Christian for your insights on manufacturing.

Thank you, Steve. So in 2022, we are paying attention to 5 key industry-specific trends. First is the emergence of digital threats which means enterprises need to melt the core of hardware manufacturing with a new requirement of being a software developer. This creates a delicate balance within cultures as companies strive for an efficient core business while also making the necessary investment in the digital threat at the same time. We've observed a focus on how to scale the use of industrial Internet of Things in a secure way and keep it protected from external and even internal attacks. Cybersecurity and ransomware dominated the headlines last year. Enterprises are leveraging the power and scalability of a decentralized public and private clouds with data being available globally, regionally and locally. Next, ESG, the environmental, social and governance area. It's unbelievable how quickly this topic has become a priority for company boards. ESG will drive energy efficiency and new monetization opportunities. For example, Maersk, the shipping logistics company has committed to green fuel and hydrogen and aims to go zero carbon by 2050, which means ships will have to be carbon neutral by 2030, and that will have a sizable impact on technology. Then rather than eliminating ships, Maersk will change the engines to run on clean energy and fuel. Another trend is the monetization of software and services. Original equipment manufacturers, OEMs, in particular, have quickly adopted autonomous features with all aspects getting connected. And the first pilots are running in production and scale, which indicates that we are at the tipping point of a massive industry shift. But manufacturers must completely rethink their go-to-market for products and services, and that's the biggest challenge. All manufacturers want to deliver a memorable customer experience. However, that desire is linked closely with their ambition to drive digital transformation and digital products and connected services. At the same time, enterprises want to move faster. To do this, they need access to skilled digital talent, but they are not immune to the labor shortages that we see along. They need to engage with the broader ecosystem to find the right resources and skills in order to monetize software services. Another point. As Stanton already said, we see a lot of M&A activity in the [ entire ] market. Within manufacturing, we see a shift happening whereas enterprises are using M&A rather to add to and not just to extend to the core, to acquire additional capacity, skill sets, specific technologies and a more verticalized product-oriented road map that complement the core business. Lastly, enterprises need to build more resilient and adaptable supply chains. Almost all manufacturing companies felt the pain as supply chains tightened during the pandemic. The imbalances, increased cost and safety concerns won't go away quickly. Enterprises may need to rethink some fundamental procurement strategies. Better demand forecasting and cost control will be key to limiting the disruption we've seen over the past year or 2. So what is it that ISG clients ask the market? First and foremost, we are hearing from clients that they need to leverage digital transformation. They want to optimize and manage their connected assets. However, that is difficult because today, organizations are siloed and split among IT, OT, ET and other business units. They are looking for the technology that can help them break through the silos. It's not simply the availability of data and integration of those. It's using a digital twin to enable the work of a maintenance engineer for large power plants, for example. The more specific the use case is, the greater the success rate of scaling it out. The adoption of cloud is still in its early stages, especially with the hybrid and remote working routines that's in here to stay. Data can be pumped into the cloud easily, but it's getting really expensive and uncontrollable to get data back out and make best use of it. When it comes to operations and spending, clients are asking how to align IT transformation to their operations technology for an integrated IT/OT deployment road map. This is because the complexity of data in manufacturing is probably greater than in any other industry. The challenge is to keep the organization running on pace, while at the same time implementing these transformational measurements. The products themselves are generating a tremendous amount of data, and that requires even greater capacity for data storage, labeling solutions, sorting and feeding it all back into future development. On top of that, the IT vendor landscape is fragmented and not delivering the necessary optimal value. This has prompted a surge in M&A activity across various aspects of the market. In addition to the surge in manufacturing M&A, there is a tremendous amount of activity in the IT/OT integration. The skills and capabilities of the existing workforce are unable to fulfill what new digital services require. OEMs are making software engineering capability a strategic priority, shifting the control point into -- in the manufacturing value chain from hardware to software and data. Digital services integrated with physical devices create recurring revenues, which means hardware companies need to master software and do this fast. Hence, the search in digital engineering M&A is occurring. But OEMs aren't the only ones pursuing digital engineering opportunities. Pure-play IT service firms are racing to capture market share in the connected devices and IoT space as well. All told, 6 of the top 25 R&D providers, nearly 1/4 of the market, have been acquired in the past 3 years. So what does this mean for as-a-service providers in the broad ecosystem? During the digital transformation, tech spending will undoubtedly increase as digital twins, for example, cybersecurity and supply chain insights drive to market. Transformation is spanning both strategy and implementation as firms combine OT with IT in an end-to-end delivery model, joint approaches and solutions and leveraging technology within business streams outside of IT. This will inevitably blur the ecosystem boundaries while also opening up new sell-to and sell-with opportunities as enterprises and service providers find innovative ways to partner, source, transform and govern. Steve, back to your forecast.

Fantastic update, Christian. So let's start with a quick summary of the year. We saw really strong demand in the managed services which ended the year up 16% in the fourth quarter. We continue to see a solid pipeline of managed services deals, especially in digital transformation, cloud and data analytics. We believe that the revenues in the managed services market will increase by 5.1% in 2022, really on this back of a strong demand side. That 5.1% may seem conservative compared to the growth we've seen in 2021, but in the 10-year period between 2010 and 2020, the services market averaged just 2% growth annually. In fact, the services market declined in 3 of those years. We know COVID accelerated digital transformation, but we think it's really unrealistic to expect that the services industry could grow by double digits short or long term. A 5.1% growth is still 2.5x what the industry averaged in the past decade and should not be taken lightly. The as-a-service market continues to grow at a breakneck speed. Year-over-year growth is strong, but the quarter over compares suggests that the pace is slowing. Infrastructure-as-a-Service and Software-as-a-Service are very different markets. IaaS is dominated by the big 3 global players, who together owns 75% of the global market. Other hand, the as-a-service market will advance about 20% in 2022, which is the lower part of the consistent 20% to 25% range we've seen for the as-a-service in recent years. So hey, guys, it's great. It's time for questions now. To join the discussion, please type your question into the chat box to the right of the slides, then click up to the arrows to send it. Bryan, at this time, I'd like to turn it over to you, and you can start the questions for us.

All right. Great. Well, thank you very much, a very insightful presentation. I'll kick it off here with a couple of questions, and then we'll open it up for Q&A. So team, I guess, the first one I have is, as we think about 2022 enterprise budgets, based on what you're seeing in contracting data, what are your thoughts on the outlook for average 2022 IT services budgets? And talk to us about the most visible areas that customers are emphasizing and then in turn, deemphasizing. And on that last point, any pockets with an exhaustion of spending or pull forward of tech spend to consider?

Yes. Thanks, Bryan. So when we look at it overall, I think technology spend is going to be held in the 5% to 5.5% range. Really, that's sort of -- that's what we predicted on the managed services side of what we're forecasting. But I think when we look at overall tech spend, the big difference that we see is spend is coming across the business. And as we talked about in the last several quarters, it's not really just spend coming from IT anymore, it's really spend coming from engineering. It's spend coming from mid office. It's really spend coming from revenue generating, and that's really increasing it. I think we're going to continue to see that trend as long as the digital transformation piece really grows because that's what's really fueling the market right now. If I think about pockets of where it may be a little down or a little bit concerned, clearly, as we talk about on the infrastructure side, infra was down 11% as we talked through. I think that's going to continue to be under a lot of pressure just as we move to the public cloud. This is SaaS adoption grows. I think as engineering, industry-specific BPO, we're going to continue to rise, though and continue to be sort of the fuel that continues to drive the market.

Okay. How about -- let's shift to large deal pipeline. So there were a handful of visible mega deals over the last 18 months, considering ones like Daimler, and Vanguard, Metro AG, Postbank but there's really been a lack of those headline revenue deals recently. Your deal analysis shows a very strong sub-$50 million and sub-$20 million deal flow. But I'm curious, are you seeing any more of those mega deals or captive targets that may be looming?

Yes. Let me answer it in a couple of ways, and then I'm going to ask, Stanton, I think you should jump in on this.

Sure.

Last year was phenomenal with this number of mega deals that we have. We clearly talked about the Daimler deal for some time. We had Metro AG. Europe was really hot. We had a lot of deal flow this time last year. But when we look at the number of mega deals, it's actually about the same as what we're trailing on. They're just not as much headline grabbing. When I look at the big deals, I think it was $1.4 billion of ACV associated with the mega deals versus $1.8 billion last year. So it's down a little bit, but it's not massive. But I think as Stanton talked about, we have seen this shift and where the deals come. So do you want to talk to that, Stanton?

Yes, Bryan. So as Steve said, I mean, actually, if you look at this kind of on a quantitative basis, the number of mega deals has actually been pretty consistent, so there were 7 in the fourth quarter, 3 in Europe, 3 in Americas and 1 in Asia Pacific. So we'll end the year at 20. We actually had 21 in 2020. So the actual number of mega deals has actually stayed pretty consistent. And I know these are big important deals, a lot of them get a lot of headlines. But as you hit on as we put into the slides, really the backbone of our industry is on the back of smaller deal sub-$20 million in ACV deals. And that's the reason I've been talking about that a lot on the inside of this year to kind of reinforce. This is a really big change in our industry, and we think it creates opportunity for not just the midsized guys, but also the bigger providers as well. And ultimately, when you look at the mega deal pipeline, we think that we're going to be something consistent this year than we were in 2021, but I think it's -- the main message here is that ultimately, the overall impact of those mega deals is declining. So if you look 5 years ago, the ACV that those mega deals contributed to our industry was about 20%, now we're down to 12%. So the overall number is staying same, but the overall impact in terms of an ACV basis has come down significantly.

I think the thing on that, that I like, though, as well, when we looked at the full ITO spend, Bryan, the full ITO spend was down significantly compared to the past, which was part of the drag on the overall infrastructure market. Then when we looked at the underlying cause, a full ITO as well as workplace services, data center, network, storage, everything kind of being combined in one deal, that market has really shifted into smaller breakups now. So we'll see data centers spend now separately because what they really want to do, consolidate data centers, move to the cloud or move workloads to the cloud so they rethink through their data center strategy. Network is being completely disrupted with SDN, 5G, edge computing, things where it doesn't make sense to just outsource a traditional network, combined with an ITO provider that we would have seen so many years in the past. Workplace services was completely disrupted during the pandemic as we talked about. And so you're seeing different solutions from the service providers come in that are more point solutions that are driving sort of those mega deals down a little bit, but also leading to the smaller dips Stan that you're talking about. So it's a [indiscernible]

Okay. And let's stay a little bit on pricing too versus wage inflation. So the 4% to 7% rate increase for in-demand skills, that's notable. I'm curious what is that in comparison to historical levels? And then just more broadly, can you talk a bit more about the risk for service providers, where enterprises may not be willing to take the higher prices that offset those notable wage inflation levels that we are hearing and how can the providers best manage that?

Well, the good news is we've got our Chief Data Officer and our pricing guru with us today. So Kathy, why don't you go through the pricing?

Sure. The 4% to 7%, as you said, is a little bit higher than what we would see historically. And that's because I think clients are really looking for strategic place from their providers in the project space, right? So they're willing to pay for high -- for the skills that they required to lead them to their transformation faster. These are strategic plays for them. They're in-demand skills and they see the value in that. On the managed services side, these are really more commoditized based services, things you wouldn't expect to see an increase in rates for. As I said earlier, they're being offset by automation and other efficiencies. But as you see organizations moving toward really industry spot solutions that are trying to -- that are transforming their business from an industry perspective and really helping to drive revenue. That's where they're willing to pay more, and that's why we're seeing a higher than average historical jump in those rates. And I think that it's very strategic and purposeful and clients are willing to pay for that.

Yes. Probably from just as an example, from a manufacturing standpoint, it's actually the intersection between typically IT and an OT areas where industry and domain knowledge will pay into those higher prices that come from adopting technology to enable outcomes and product-oriented business value. And that is, if you take anything AI, data scientists, data engineers, that is one spot where we can really see not only scarce resources and lack of skills and capabilities in term organizations, but really paying a measurable outcome into the business management [indiscernible]

And for providers now, when we talk to them, they're always coming with an industry perspective. It's an industry-led perspective, it's how they understand an industry, what spot solutions that they have. And clients value that perspective and that assurance that they're going to get the required skills and knowledge they need to really drive a transformation.

Yes, I think that's good.

Okay. I'll pass it back to you to take questions from your queue. Great.

Thanks a lot, Bryan. So we do have some questions teed up. The first question that we had is we did -- we talked about sequential growth, it was flattish Q4 and what sort of our perspective on the peak and are we at the peak of demand? In general, I would say, and we talked about this in the last several quarters, we had a very big Q2, Q3 this year. And the Q2, Q3 growth that we had, we knew that, that was associated with a lot of pent-up demand. And we talked about that in Q2 when we saw the numbers I talked about it beginning in Q3. And we had forecasted kind of coming down a little bit. I think the good news was, is really where the growth was. So apps and engineering were up phenomenally. That really shows sort of this whole market that we talked about with digital transformation, the software is eating the world that is not just SaaS. It's SaaS and bespoke development, enterprise application development and enterprise app modernization. And so that's going to continue. And I think what you'll see is that we'll continue to increase the demand. We're going to continue to see large pockets of growth outside of that. And when we talked about the growth, I think we said 5.1% growth for the -- for year -- for 2022. That's sort of in line where we see the tech spend coming and that was for the managed services number. That's still 2.5x what it was in the past. This market has typically grown 2%, 2.5% over the last decade, and it's really only in the last 2 to 3 years some of the pent-up demand, some of the digital accelerated, some of the pandemic accelerated that really drove it. And we really don't see those kind of those big tailwinds changing. Matter of fact, I think they're going to accelerate as we start talking about even more technology spend associated with crypto, with DLT, with Metaverse with so many of the key trends. We know we've got autonomous driving coming up. We know we've got EV, which is completely changing manufacturing. We know we've got these big megatrends that are impacting banking, fintech, et cetera. So I think we're pretty optimistic about where the demand is coming from and that increase in demand going into next year. So the next question that we have is companies like Accenture are saying clients are open to higher prices for new contracts. And Kathy, I know we've done some perspective on this. We've done a lot of analysis. What's your perspective on the pricing again?

Right. So I think what we said the reverse is in the managed services deals. And in terms of companies like Accenture, are seeing that people are willing to pay more, that's where that 4% to 7% increases. And that is in those specialized areas. It's in all of the different trends Steve was just talking about where it's critical to the business to move it forward. They are willing to pay more. So I don't want you to think that clients aren't willing to pay more, but it has to be a high-value area. It can't be something they see as commoditized.

Yes, I think that's fair. I think the key thing, and Stanton, you talked about this as well why don't you just start with labor. Just because labor is tight right now and the labor markets are probably even for core steels, that doesn't mean that we're going to be able to transfer those costs with it. I think you both mentioned that we're going to have to do things more leverage. We're going to have to do more pressures. We're going to have to do more training. There's a lot of things that we're going to do as an industry that we can't necessarily pass over. Any thoughts on that, Stan?

Yes. And I think ultimately, as we've talked about and you talked about earlier, Kathy, is I think when you think about the levers that service providers are having to pull to adjust to this, it's not a silver bullet. There's not one thing that we're doing to adjust to the great resignation. It's around automation and extreme levels of automation across entire stacks, and we've seen this and talk about this a lot how more and more, and this actually kind of what goes back to a question around shrinking deal sizes. More and more what we see happening is moving to more of a product-oriented operating model and more product-oriented services. So if you think more about like a vertical stack rather than a horizontal row, right? And then when you do that horizontal called stack and those become more standardized, you can drive more automation into those, you can create more leverage around those stacks. I think that's really where we're headed. And I think that's ultimately then going to have a downstream impact on pricing, both on the project rates and on the managed services side.

Yes. Excellent. All right. The next question that we have is how is the deal renewal being looked at in 2022? Do you feel mega deals will be broken into small ones? So Stanton has done a lot of research on this as well as part of our ISG Insider. One of the things that's really interesting, though, this quarter is just the breakout of deals. So I think when we looked at it, it was -- let me just look at the number real quick. It was almost -- let me get the number here real time, I think it was 65% of the deals were new scope this quarter or this year. So which again goes back to all of the new things that we're seeing brought in new areas, new spend being brought in, and that certainly had an impact on the mega deals. But Stanton, do you want to take that?

Sure. Yes. I think as you think about the renewals, we actually wrote about this a few weeks ago, so there's $18.5 billion of ACV coming up for renewal in 2022. About 75% of that is ITO, 25% is BPO. Actually, about 1/3 of that is going to come from BFSI, which is traditionally the largest consumer of managed services. So we talked also about the fact that 80% of the deals are less than $20 million in ACV. So we think that pattern is going to continue. Actually, something that's kind of interesting is if you look at that deal [ banding ] that actually shrunk a little bit. So what that means is that deals are getting slightly bigger but they're not getting to the mega deal size, right? They're getting to more of that $20 million to $50 million range. So we think that trend will continue. We think the trend around the consistency of the number of mega deals will continue. But ultimately, as we just talked about, many of those deals are going to be broken into smaller chunks, more product-oriented, more kind of a vertical stack. And then another key trend that we do see happening is it's kind of going back to, if you think 10 years ago, around service integration and management SIAM right? This idea that service providers are working with other service providers to deliver these services. We are seeing this happen more and more as we look at a lot of these larger deals, that smaller midsized providers are taking on more of these product-oriented stacks. And I think that's creating opportunity for both the big and the small providers.

Christian, what are you seeing in manufacturing on the deal sizes because it's 20% of the market that you have?

Yes. I was noting all within [indiscernible] actually I see those 2 elements. One is exactly the product oriented, business oriented, let's say, end-to-end solutioning that will include a variety of all the required skills across all the stacks of infrastructure applications and also business topics and bringing together this IT/OT topics that an engineer knows how to explain what his requirements are on an ingestion or labeling, process in developing an autonomous driving solution. But explaining it to the IT technology guy that sits in infrastructure and have to handle the Hadoop platform, and this comes end-to-end. So this is verticalized. So this is the kind of deals we're seeing. On the other side, the splitting up of those one highlander principle, one-takes-all infrastructure application, a typical ITO area. It's more going into best of breed and also following the steady change in adoption of it and keeping it flexible, keeping it like in constant competition for application development pieces and very much looking for the specialized and midsized company. So can only affirm executed topic for manufacturing. And those differentiate, again, that bring in the industry solutioning perspective and can openly collaborate with other providers and best of class providers in their competition from them.

Yes. I think the [ banding ] is going to be a key issue as we go through. Maybe I don't want to sign you up for anything real time. But maybe what we do is say on the Index Insider, we really take a look at the bands and maybe even buy the type of business and show how those bands are changing because I think it does have a big impact on the market.

Totally great. Totally agree.

Absolutely. Next question -- and remember, you can input your questions on the right-hand side of your slide. So if you have more questions, just go ahead and key them up. Next question is, could you explain the increase in BPO services markets? What are the key drivers? As I -- we talked about in previous quarters, the big driver for the BPO growth right now is engineering. For lots of reasons, we have counted ER&D within the BPO space. We're going to break that out this year, but we wanted to be consistent for the full year of 2021. And engineering is phenomenal. Engineering is now almost 25% of the BPO market. We delivered over $1.8 billion of ACV in engineering, which is up 170%. So the numbers are just phenomenal, what we're seeing on the engineering side. And as Christian, as you said, this spend is coming from so many different sites now. Manufacturing is clearly a big driver of it. On the BPO side, though, as we discussed, some of the traditional BPO spend was still pretty flat. HR was up, which was really good. We are seeing good growth on the HR, especially on the HR tech side. Facilities management was up compared to a very dismal 2020. So staying up is relative when it comes to lease management. Especially in Europe, we saw a nice return on the facilities management side, but nothing like pre-pandemic levels. Contact center was flattish, not up a lot, especially again compared to the pandemic days. So we don't expect a lot of growth on that side. But Christian, any thoughts on, again, just the BPO probably just the manufacturing?

BPO. Well, I think you pretty much nailed it already. But probably just one piece on -- well, actually, I think you nailed it, sorry. That's all.

Of course, we nailed it.

Excellent. So the final question that we have -- oh wait, we've got another question coming in.

So I think the final question, Steve, was kind of rationale around why we think the attrition challenge is going to be solved over the next 2 to 3 quarters. So I can take a stab at that, and we all -- obviously, we all have a point of view on this. But ultimately, it all comes down to supply and demand. There's massive demand for, as Kathy talked about, these specialized skills. Every company across every industry is looking to accelerate their digital transformation. During the pandemic, hiring abated, right? We're all enterprises and service providers, right? We're looking to reduce costs, and we are all being conservative during the pandemic. And but that demand went through the roof, right? Right at that time when many companies and providers were being conservative in their hiring. So we're in a mismatch right now. So the reason we think that this is going to abate in the next 2 to 3 quarters, is because a lot of that hiring has already started that campus-based hiring of freshers essentially. So folks right out of school that are trained on a lot of these new skill sets. So that has started maybe 2 to 3 quarters ago was when a lot of this hiring really started kicking in, and it's still happening right now. So our view is that those folks are starting to come online now. And over the next 2 quarters or so, they're coming online. It also kind of comes to this pyramid issue of if you don't necessarily have the folks with exactly the right skills or they're necessarily skilled up enough yet and you add more people to the mix, right? So they can deliver more between a group or potentially a pod, distributed globally. So that's really the rationale is that we think a lot of that -- those folks are starting to come online, they're ramping up and that kind of mismatch between supply and demand is going to get fixed. I don't know if you guys have a point of view on that.

Yes, I think you're spot on. We do have other questions coming in. The next question is, do you think a provider's commitment to ESG will have a tangible impact on purchasing decisions going forward? Great question. Again, I'm honored to have Kathy here because Kathy's actually our CSR and ESG expert for the firm, both internal and external. So that's good. Let me start by saying a couple of things, especially on the E side. We expect to see significant spend on the environmental sustainability side as we go forward, really around carbon reduction, both for the IT spend, the footprint within organizations. But even more so, what can organizations do from a technology standpoint that make a more sustainable business for all of us and a more earth-friendly business for us. But Kathy, I think as you've looked at the ESG component, I think we believe that it is going to be a tangible benefit, and it will be part of the procurement process. But any thoughts?

We absolutely do, and we have really started taking a look at providers' commitment to ES&G, and we're going to start reporting that out. And it's really taken off starting in Europe and moving then to Asia Pacific. It is coming to America. But clients are asking more and more about their ecosystem and their supply chain commitments to the environment as well as social modern slavery is a really big issue and governance, how well is the company governed and will they be around tomorrow. So this is top of mind. It is something I've been focused on with our time here at ISG. And that's a great question because 100%, it is important, and it will continue to grow.

Just 2 thoughts on this in addition. So the one thing is ESG -- the question at the moment, everybody is dealing with how to really measure it, make it comparable and how to keep it transparent. So a lot of focus at the moment is to up to the Board, make the ESG measurements, measurable and transparent. The second thing is it has a cost opportunity. So where can you use technology to avoid energy consumption, which is one of the actual manufacturer highest price drivers ever. So where can you use technology, for example, to drive down energy consumption where you have smaller solutions, where you can probably completely disrupt formally flying engineers somewhere offsite and using technology like digital twins to compensate. So that's where you can really bridge ESG with technology and the business service providers can bring to the table and therefore, it makes real sense to differentiate there.

So just one last point on that. And organizations are looking at not only their impact on their clients, but what is the risk and impact to them and their business. So it's twofold. So what is the risk to them from environmental, social and governance. So they're looking at it from an internal perspective as well as an external perspective.

Yes. I love the fact that what you said, Christian. So the rise of digital twins, VR, AR is all going to reduce the overall carbon footprint for organizations as we go forward.

And just one last thought on this, you can go across, this is now ESG, but that's again how you put new technology, enabling technology in the context of a business outcome, business ESG, this is digital twin. It has an outcome versus outcome. And if providers and then technology providers would put every time, they're enabling technology into the context of this business outcomes and make it transparent and measurable, they will be opened up for also higher prices like Accenture.

Right. Excellent.

Well, thank you, everybody. Brilliant session. Thank you, guys. Kathy, let me give you for the final words from you.

All right. Great, Steve. Really special thanks to Bryan and the team at Cowen for hosting today's call and to everybody in the audience for making time to join us. We'll be back again to analyze the first quarter of 2022 on Wednesday, April 6. So be on the lookout for an invitation on how to register for that. In the meantime, please stay safe. And one thing I'm really hoping because we did this live is I don't ever see a bloopers reel of the practice session yesterday. Thanks, everyone.