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

Good morning, good afternoon and good evening to all the investors, service providers and corporates who have joined the call today. I, Rishi Jhunjhunwala, on behalf of IIFL Institutional Equities, welcome you all to the First Quarter 2024 ISG Global Index Call. I'd like to thank the team at ISG for their valued work on the industry and for asking us to host the call today. ISG has been hosting these index calls on the IT and business services industry for more than 20 years. IG influences more than $200 billion of tech spending each year, giving them deep insights in the industry as well as the key changes in the enterprise demand, is also one of the largest outsourcing consultants in the world, helping more than 500 corporates globally. With that, let's see what they have to say this quarter, I'd like to pass over the call to Stanton Jones, distinguished analyst at ISG. Stanton, over to you.

Thanks, Rishi, and hi, everyone. With me today is Kathy Rudy, Chief Data and Analytics Officer. Steve Hall, President of EMEA and Chief AI Officer; Namratha Dharshan, Chief Business Leader for ISG India, and Alex Bakker, distinguished analysts. This is our 86th consecutive index call. So whether you've been joining us for all of these years or are new to the call today. Thank you for investing some of your time with us today as we give you ISG's point of view on the health and growth of the IT and business services industry. Steve, over to you to kick us off.

Thanks, Stanton. Let's start with 3 big thoughts: The managed services market declined based on weaknesses in the Americas market. The cloud growth returns on strength in big 3 hyperscalers, and we continue to see AI monetization, but with flat IT budgets, it is going to take the reprioritization of spend. If we take a look at the global markets, the combined market rebounded in the first quarter, generating nearly $25 billion of annual contract value. That's a 4% year-over-year increase, and it was the best combined market since 2022. It also represents a third straight quarter of sequential increases. The managed services market generated over $10 billion of ACV for the sixth consecutive quarter. The overall managed services ACV declined year-over-year after generating just over $10 billion of ACV. The banking sector continued to be under pressure in the U.S., which accounted for over 70% of the decline in the managed services market in the Americas. The BPO market was strong in EMEA, up 40% year-over-year and 22% quarter-over-quarter. We also saw surge in bundled ADM and infrastructure activity across the market. We continue to see a sustained growth period in managed services, driven by demand for cost optimization. This was only the second quarter in the past 15 quarters where year-over-year comparisons turned negative, but primarily due to strong compare versus weaknesses in the market. Large deal activity was muted in the first quarter. There were 4 mega deals in Q1 compared to 8 in Q1 of 2023, but smaller deals were also impacted by the slowdown in discretionary spending. We saw a 3% decline in deals between $5 million and $30 million. The pause in discretionary spending at the enterprise level continued to impact managed services and consulting services across the industry in Q1. The As-a-service market returned to growth, posting the best quarter results since the third quarter of 2022. The As-a-service market generated $14.6 billion of ACV, up 7% year-over-year. The growth in the as-a-service market was led by a rebound in the infrastructure as a service market as clients increase cloud spend and Gen AI began to increase cloud usage. IaaS also grow through the $10 billion ACV mark for the first time since 2022, and was up 11% year-over-year and 12% quarter-over-quarter. The as-a-service market now represents almost 60% of the combined market and it is a big reason why the overall market is up 4% year-over-year. Turning our attention to the Managed Services ITO market, which includes applications and infrastructure outsourcing. The market generated $6.8 billion in ACV, which was down 2% year-over-year and down 13% quarter-over-quarter. This was the lowest quarterly ACV for the ITO market in 2 years. The applications outsourcing market continued to account for almost 65% of the total ITO spend, continuing the transition to application sourcings we've discussed on previous calls. Stand-alone application ACV remained above $4 billion of ACV this quarter but was down 7% year-over-year, primarily due to a slowdown in demand in EMEA and Asia Pacific. We did see growth in bundled ADM and ITO deals though, where applications were bundled with infrastructure. This market surged 130% year-over-year, 42% quarter-over-quarter and was up already 40% from its 5-year averages. This continues to highlight the cost optimization within organizations and move to bundling to further reduce cost. The strength in the application market will continue in 2024 in large part due to AI. As we've mentioned on the index insider earlier this year, enterprises have an enormous amount of data stored in their legacy applications. It's hard to move AI projects forward without data. So we believe we'll see more ADM activity this year, focused on modernizing applications in order to move forward with AI plans. Data center deals were down significantly this quarter. The number of deals and associated ACV were both down more than 50% year-on-year and 13% quarter-over-quarter. Namratha, what are you seeing in the BPO market?

Thank you, Steve. BPO had a solid quarter with ACV of $3.2 billion, was up 1% year-on-year, but up nearly 40% sequentially. Contracting activity was strong with over 240 contracts awarded, that's the third most ever. Industry-specific BPO generated about $1.1 billion of ACV, and that was down 6% year-on-year. But any time this segment generates over $1 billion of ACV. Its strong result, and we see this demand in this segment accelerating, especially in areas like banking and insurance. Engineering also had a strong finish in the first quarter with over $800 million of ACV. It was up about 30% year-on-year. The first quarter of 2024 was the best quarter for engineering since the fourth quarter of 2022. Could be an early indicator that discretionary spending is starting to loosen up in critical business functions. Another interesting area is finance and accounting. ACV here was up 13% year-to-date. As we discussed a few weeks ago on Insider, digital arbitrage is having a big impact here in driving down the cost of finance and accounting operations. This, in turn, driving down award sizes while the number of awards increased. We continue to see peaked interest in transformation deals with cost optimization being core or central to it. BPO is no different because according to our bio behavior research, saving costs is one of the top reasons for outsourcing. Also today, the BPO value proposition is heavily driven by technology. And nearly half of the enterprises are looking to leverage technologies such as AI and automation to reduce external staffing in the next couple of years. Now that said, enterprises are not just looking for technology partners and providers, but also someone who understands the current business needs, become more of strategic partners addressing efficiency, innovation, industry expertise, et cetera. With that, Kathy, I'll hand it over to you for the update on regional demand.

Thanks, Namratha. Starting in the Americas, ACV pulled back in the first quarter of 2024 with just over $5 billion of ACV. This was down 8% year-on-year. The weakness was due to several factors. First, both new scope and extension and renewal ACV saw pullbacks in the quarter with only 2 mega deals awarded. This was the slowest quarter for Mega deal since the third quarter of 2022. The biggest factor, however, is BFSI in the Americas. It continues to be under pressure, down 18% year-on-year. For perspective on how important this industry is to the region. The slowdown in BFSI accounted for over 70% of the overall decline in the Americas. There was some upside in the Americas this quarter, energy and travel transportation and hospitality posted double-digit gains. Some of the larger sectors like manufacturing and healthcare and pharma each posted gains of slightly above 2%. And unlike EMEA and Asia Pacific, the Americas did see an increase in stand-alone application deals in the first quarter. The slow start in the Americas is concerning for the overall market, and we'll be watching this closely. In EMEA, ACV of $3.9 billion was up 3% year-on-year. Growth primarily came from BFSI, which was up nearly 5% year-on-year. BPO was up 40% year-on-year on a $1 billion-plus quarter, driven by strong demand for industry-specific BPO. And by region, the U.K. posted its fifth consecutive $1 billion-plus quarter, and the Nordics had its best quarter since 2016, while France and Dock were both down year-over-year. In Asia Pacific, ACV was up 18% year-on-year on strong contracting activity. BFSI drove nearly all of the growth in this region in this first quarter, up triple digits versus the first quarter of 2023. BPO was also strong in Asia Pacific in the first quarter. Now let's move on to the managed services industries. This quarter, we're going to focus on BFSI and manufacturing sectors, specifically the combined market of managed services and as-a-service. This will provide a wider lens into the overall technology spending in the sectors. The BFSI combined market was up 3% versus the first quarter of 2023. This was based on solid results in EMEA and very strong results in Asia Pacific, offsetting the weaker results in the Americas. As a service versus managed services drove the 3% growth in this quarter. BFSI as-a-Service was up 8% year-on-year versus the first quarter of 2023, while Managed Services was down 1% on weaker results in the Americas. 48% of the BFSI combined market now comes from as-a-service. That's up from 41% a year ago, but most of that increase is coming from weakness in managed services rather than as-a-service growth. As we've discussed on previous calls, as BFSI goes, so goes the market. That's especially true in 2024 as a recovery or pickup in BFSI technology spending is predicated on the easing of the monetary policy. If Central Banks chose to stay high for longer, it will likely continue to weigh on the sector's performance and, in turn, overall market performance. Let's turn to the combined manufacturing market. It struggled in the first quarter with ACV down 6% compared to the first quarter of 2023. This was a broad-based decline with each of the 3 regions in the negative in the first quarter. Both Managed Services and as-a-service were down. In Managed Services, we saw a lot of pressure on smaller deals, those between $5 million to $10 million ACV and these were down 18%. 57% of the combined market ACV comes from as-a-service segment, and it is up 54% from a year ago. But like BFSI, that's a result of sluggish managed services results. On a positive note, the Institute for Supply Chain Management, known as the ISM Manufacturing Index rebounded in March, the first expansion in 17 months. The report showed strength in new orders, production and employment. Notably, 4 of the largest manufacturing industries, food, beverage and tobacco products, fabricated metal products, chemical products and transportation equipment all saw growth, which is great news for the industry. Stan, over to you for an update on what we're seeing happening in cloud.

Thanks, Kathy. For those of you that have been following the call or the index insider weekly briefing, you know that we've been talking about the downward trend in Infrastructure as a Service for over a year now, while that changed in the first quarter of 2024. Infrastructure as a Service generated $10.6 billion of ACV, which was up 11% year-on-year. And that's the best result for this segment of the market since the third quarter of 2022. And we've had a number of inquiries lately around which industries are recovering fastest from the cloud downturn. In Q1, telecom, energy and Travel and Transportation saw the highest ACV growth rates. And looking specifically at the big 3 hyperscalers, which make up about 70% of our infrastructure as a service basket, ACV was flat year-on-year. But it's important to remember that for the last 4 quarters, the big 3 have averaged a 22% decline in ACV. So flat is yet another signal that Infrastructure as a Service is starting to recover. And finally, when you add in the fact that much of the cloud optimization that we saw happening over the past year with our clients is starting to come to an end and add in the incremental demand that we're seeing from enterprises to AI-enabled their applications in the cloud, we think Infrastructure as a Service will have a strong year, and you'll see that reflected in our forecast from Steve here in a bit. Okay. Now let's take a look at Software-as-a-Service, SaaS ACV of nearly $4 billion was down 2% year-on-year, and most of that was due to the performance or lack thereof of the top 10 SaaS firms. Their ACV was down 11.5%, and that's in contrast to what we saw in 2023, where the top 10 SaaS providers posted positive results for most of the year. By category, last quarter, we called out human capital management, or HCM, as one that continues to perform better than the overall segment. As you can see here, it was up 3% year-on-year, and that continues a steady asset for HCM that really started back in 2022. Collaboration and content management were also up this quarter. On the other hand, several categories continue to see ACV declines. IT service management and ERP were both down against difficult 2023 comparisons and CRM continues to struggle. This is the sixth straight negative quarterly year-on-year result for this segment. That said, we see lots of green shoots in SaaS. As Alex discussed on the insider a few weeks ago, enterprises plan on doubling the number of AI enabled applications in their portfolio this year. And in our view, the fastest way that they're going to get there is via their SaaS applications. And they're also willing to pay more per seat to get access to these AI features potentially signaling that SaaS has pricing power even in this inflationary environment. Okay. That's it for our cloud update, Kathy, back over to you for an update on what we're seeing in pricing.

Thanks, Stanton. We look at pricing in 2 ways: managed services pricing and timing material or project-based pricing. First, let's talk about managed services and analyzing the data and ISG Pro benchmark pricing platform, we typically see a reduction in managed services [indiscernible] or resource unit pricing of about 2% to 4% on average a year. But when we look at the pricing data for 2023, we're seeing pricing closer to flat rather than decrease. In the areas where unit prices are increasing, they're typically labor-intensive services requiring people, resources to deliver or rely on third-party software, which adds to the overall unit price or rate. [indiscernible] prices are dropping, benefit from increased automation. I'll talk a little bit more about what we're seeing in relation to AI and Generative AI in a moment. Now let's move to time and material and project work. There, we're seeing a 2% to 5% increase in base rates across the board. For Max in Europe, they're on the lower end of the 2% to 5%, and we're seeing the higher percentage increases in India, where annual wage increases are typically higher. For advanced skills such as big data, AI and cyber, we're seeing rate increases as high as 12%, which in the past quarters was as high as 15%. Now let's take a quick look at the impact of AI and generative AI on pricing. Current view is that savings gains remain uncertain despite a surge on interest in AI following the introduction of generative AI. In a study where we collected over 140 use cases for AI and generative AI from providers, we asked them what was the expected savings for clients. But we actually reported expected savings between 30% to 60%. However, we've seen that filter to the market yet. We also feel this could be a heavy lift, especially for mature outsourcing clients that have already realized the benefits of labor arbitrage in the first wave of predictive automation. We'll be keeping an eye on it because we too are interested to see where generative AI can push not just use cases for Generative AI, but also to expand the market for AI in general. And now it's over to Steve for more on AI.

Thanks, Kathy. Great update on the pricing and the impact of AI. So for everybody's use of this, we have added a new section to the ISG index this quarter to reflect the growing demand in the AI market. We're primarily going to be tracking the activity with service providers and AI-specific solutions, but we'll also provide commentary on the growth of large language models and the hardware and chip layer as appropriate. We'll also make sure that we continue to have a special focus, which Alex Bakker will provide today on the market lens on AI buying patterns. We all know we're on the high train in this market, but it's a market that's still evolving. Just to put it in context, it's only been 6 quarters since the launch of Chat GPT, which demonetized AI for the masses. Over these past 6 quarters, we've accelerated through media mentions of capabilities investments in tools and training. And finally, within the last 2 quarters, AI-driven revenue. At ISG, we began tracking the AI activities of the top 30 service providers, not everyone reports in the same manner, but we're starting to see scale with service provider offerings. Over the last 12 months, over $6 billion was spent on AI projects. Investments remain in the billions as organizations continue to train resources and roll out AI-infused offerings. For example, Accenture reported bookings of over $1.3 billion in generative AI projects in just the past 12 months. IBM, DXC, Capgemini, CGI and Cognizant all publicly announced hundreds of projects that are scaling across their enterprise clients. Wipro announced training over 250,000 engineers and created AI 360 to wrap AI into their offerings. Teleperformance and other top customer experience firms are rapidly integrating Gen AI into their solutions to enhance both the agent and the customer experience. Though AI-specific projects represent less than 2% of the total market -- the total service provider revenue today, we expect this decline and will report changes quarterly. We're also watching the changes in the enterprise spend. Alex, do you want to give us an update on what you're seeing in the enterprise level?

Sure. Thanks, Steve. In the short term, enterprise AI initiatives are focused on cost reduction. And in the longer term, that focus shifts to revenue generation. In our studies, we see a substantial mismatch between the near-term AI enablement goals following to the IT department and the long-term revenue focus for AI championed by the CEO and the lines of business. What we don't see yet is alignment between that long-term demand for AI to drive revenue and confidence in the IT service providers' ability to drive that business growth for their clients. IT budgets have tended to be flat year-on-year. So AI investments come at the expense of other parts of the business. With cost optimization projects struggling to pay back and rates flat rather than down, much of the AI that IT will be adopting is likely to come from discretionary project work and from their SaaS tools, many of which have already begun to roll out AI features. So where is the investment in AI to drive revenue coming from? And the data we have so far and is likely that the line of business budgets will spend on AI as well. And while we expect many of these initiatives to ultimately be governed and managed by IT, we expect the CEO and lines of business to drive the strategy as well as the creation and evaluation of use cases. The IT service providers need to balance the needs of departmental constituencies, CIO versus CEO, time horizons, short and long term, and motivational cost savings versus productivity versus expertise. Being able to align solutions to clients across these axes is critical to being able to identify the messages that resonate both within and across clients. Last but certainly not least, AI represents a new frontier for the ways that IT service providers and clients manage technology risk. Short term, AI use cases can support the productivity of workers in a human in the loop capacity, meaning that the results of the AI are meant to augment workers, but also that workers are meant to provide quality control oversight to the results the AI gives them, most, but not all of the production use cases we have seen are doing this now, specifically to avoid issues with hallucinations like we have seen in several customer-facing AI bots recently. Clearly, for the long-term revenue generation or long-term cost savings, AI will eventually need to be customer-facing, either to support new products or sales or to perform tasks in their entirety. For this to happen, the technology will need to mature to incorporate more sophisticated approaches for results validation, but also for evaluating and assigning the risks of errors. As of now, models, training data implementation and end users all play a role in determining what response an AI can get. With all of the projects and proof-of-concept work going on in the market, it's easy to lose sight of the role that scale and risk management have in the business case for AI. But for service providers or enterprises to focus on either revenue or cost savings, the industry will need to agree on a framework for managing both responsibility and liability. Namratha, over to you for an update on the leaderboards.

Thanks Alex. As a reminder, providers are listed in alphabetical order, and positioning is based on annual contract value signed over the past 12 months. The company is new to the list are denoted with an asterisk. And also as a reminder, the regional leader boards can be accessed on the ISG website. In the largest group, we observed very little turnover in the leaderboard as the leaders have exhibited quite a strong hold in their top 15 positioning. This quarter, we saw NTT Data rejoined the leaderboard. Let's look at some of the larger awards that got signed this quarter. First up, TCS, and their 15-year mega deal with U.K. insurer, Aviva to support their digital transformation and rationalize its systems. Also, we saw Infosys signed a large multiyear contract with Singapore specific international lines to help revamp their existing customer portal and deploy a scalable modern technology platform for them. And finally, we highlight Cognizant's award with Pon IT where they will provide cloud managed services across its suite of operating companies. In the Building 15 group, we saw providers such as U.K.-based computer center and customer engagement provider Concentrix rejoined the leaderboard. In this group, we'll also call out Genpact, who signed a 5-year deal with Tropicana brands during the quarter to reengineer global business services and automate a wide range of essential finance and accounting services. In the breakthrough 15 group, we saw a wide range of engineering providers such as AFRY, Alten, LTTS, Persistent Systems and Sweco make the leader board. During the quarter, Sweco announced a major framework agreement worth EUR 100 million over 10 years to provide consultancy and ER&D services to [indiscernible] in the Netherlands to support them with the development of energy infrastructure. Finally, in the booming 15 group, we also absorbed a healthy representation of engineering firms as well. In this group, we see firms such as KPIT Technologies, Endeavor, Tata Technologies, all make their leaderboard. During the quarter, Endeavor signed a large 5-year deal with Equiniti to support the delivery of Equiniti's product and engineering transformation. Tata Technologies was also in the news very recently with BMW to form a JV, which will deliver automotive software, including software-defined vehicle solution for BMW Group's premium vehicles. They also are going to help with digital transformation for their entire IT business. Tata Tech will staff about 100 of its employees on this particular JV, but that number will go up soon to about 1,000-plus employees. Congratulations to all the companies that made it to the leaderboard. And on that note, Steve, I will hand it over to you to close it out with the forecast.

So as we stepped into 2024, the outlook was brighter than the previous year. Despite this optimism, though, the managed service market slightly underperformed against the forecast, making a rare dip with a 1.4% year-over-year decline. The sector still delivered over $10 billion of ACV, though, in the quarter and has been enjoying sustained growth, making the recent dip more of an anomaly than a trend. The Americas experienced an 8% decline with the BFSI vertical seeing an 18% drop, which accounted for 72% of this decline. EMEA grew 3% year-over-year despite deceleration in key markets such as DACH in France. Asia outperformed both regions with a solid $1 billion-plus quarter, up 18% despite a downturn in the ANZ region. As-a-service market battle mix forces, Infrastructure as a Service was up 11% year-over-year, overcoming difficult compares. The big 3 hyperscalers are moving beyond the AI hype cycle and really starting to see growth. The SaaS market retreated slightly with previous resilient sectors like ITSM and ERP joining CRM solutions in a prolonged downturn. Looking ahead to 2024, economic conditions are forecasted to be less volatile than the previous year, but we think challenges persist. The global economy is anticipated to slow down with growth rates easing all of this monetary policies to combat inflation begin to take effect. This moderated growth has seen as a balancing act steering the economy towards a more sustainable expansion without triggering a sharp downturn. Inflation, which has been a pressing concern, is still expected to decline. The Bank of England has signaled confidence that inflation rates will move closer to the 2% target, following the trend of easing price rises. The Federal Reserve is similarly positioned with expectations for a normalization of interest rates by mid-2024 if inflation continues its downward trajectory. Service providers top line revenue remains flat with declining margins. Margins continued to decline faster than forecasted revenue growth, but no major industry-wide cost reductions have yet to occur as we've seen in the tech and consulting businesses. From a broader marketing perspective, we will monitor service provider hiring activities as an early indication of their trust and a broader recovery. Outsourcing could continue to see a boost as companies seek to balance the dual imperatives of cost management and service quality. Enterprises will continue to seek service providers that can offer innovative solutions like the integration of AI and automation to enhance efficiency and offset the wage inflation seen in their domestic markets. Generative AI is posed to be a growth catalyst with large hyperscalers expected to manage to increase workloads. The day of the layer integral for training AI models presents a prime opportunity for service providers. Enterprises will remain focused on data optimization as a [indiscernible] to leveraging AI technologies. In certain verticals, especially those with significant process components like financial services and media are on the cusp of extensive reengineering, promising substantial long-term payoffs. In the near term, a rebound in sectors such as BFSI in Americas and manufacturing in Europe is essential to the growth of the industry. The market needs a resurgence of smaller discretionary deals and growth in stand-alone ad bills. Key technology spend areas like cloud migration, data modernization and cybersecurity are all expected to grow. Given these factors and the headwinds of first quarter, we are lowering our 2024 forecast 125 basis points to 3% for the year. The lower forecast projects a stronger second half with some continued headwinds and delays in enterprise spending. Our forecast for the as-a-service sector remains at 15% growth for the year. This brings us to the end of the formal call. We'll now open it up for questions. Please type your questions in the comments on the right side of the screen. Rishi, would you like to start the questions.

Yes. Thank you so much, Steve. That was very, very insightful as always. What I would love to kick off with is -- there are some very interesting data trends in the index this time. Contrary to last year, as a services started picking up off a low base, but also is probably benefiting from AI adoption. While on the other side, managed services and ITO within that seems to be under pressure. And I guess some what of base effect is also under play. A large decline in U.S. BFSI and small-sized deals within managed services seem to be a bit concerning. I'd love to hear some color on each of these aspects and the reasons behind it.

Yes, absolutely, Thank you. So a couple of things to unpack there. First of all, I think the economic news just keeps changing quite a bit as people look. So when we were first preparing into last week and thinking through all the data, CPI was at 3.7%, expected to go lower. It popped a little bit in the U.S., as you know, and it's looking more likely that the Fed won't be doing anything on the interest rates. So again, we're sort of looking at a mid to back half recovery on some of the demand side. It was a mixed message this period, especially on the managed services side. But the good news is we had another quarter that was over $10 billion of ACV. So as I said on the call, that's 6 consecutive quarters over $10 billion, which is really good. I mean it still shows a lot of strength. Spend is coming from lots of areas outside of just IT. So it's not a zero-sum game by any stretch. But we're still concerned about the spend in banking and BFS more than anything. As we've said before, that's 35% of the market generally. We did see a downturn in the U.S. market on banking that was much lower. I think the number that Kathy reported was it was almost 70% of the decline in the U.S. was due to banking. That's a big impact, and that's a big sector. But we're still seeing really strong piece. Kathy, do you want to talk a little bit about the Americas though?

In regards to banking, we were starting to see some increased activity there where -- we had in the past at the end of this -- of the first quarter. I don't know where that will go with the latest news yesterday on inflation. And I think everyone was really hoping that we would see a rate reduction. But I think there's some pent-up demand, and we just have to keep an eye on it. We were really expecting it to move along and yesterday's news just wasn't what we were expecting or wanting to hear in that space. But we have seen some pickup. We really had, and hopefully, those deals will move ahead. And again, there's just a lot of delayed decision-making across the board in almost every industry that we're watching.

Rishi, you mentioned on the last part of your question, you mentioned the smaller deals. So that's something we've been tracking for the past several quarters as well. So definitely a decline there. I think a couple of things there. Number one, definitely a decline in smaller, more discretionary type work. We've been talking about that for over a year now, pressure on discretionary work. Many times those smaller deals tend to be more discretionary. But I think it's also just important to keep in mind that you could argue in some ways inflation is just having an impact on award sizes as well. So some of those have just moved up to a higher tier. So I think it's a combination of both of those things. It's putting pressure on the smaller awards.

Understood. The other aspect is that there's been a lot of debate about GCC or global captives. Their acceleration and potential market share gains from the IT outsourcers. Can you give some insights on if GCC activity remains as strong even now? Or is it slowing down? What kind of work is going to them? And if this is one of the reasons for lower contracting activity for the outsourcers.

Yes. Great question, Rishi, because we were going to talk about GCCs again, but we felt like we were beating the drum so hard on over the last 3 quarters. We decided to bring in some other topics. We're still seeing really strong demand for GCCs and really strong growth across that. It's coming up in all of our buyer intense strategies or what we call our ISG market lens. It's coming up in all the conversations that we're still having with clients. It's interesting, though, because as I shared a couple of quarters ago, it's still just as many clients that want to create a GCC to serve our clients that want to exit the routing fee. And it's really balanced depending a little bit on the sector, the size of the organization and the types of things that they're doing. But Namratha, do you want to add some color on what you're seeing on the hiring side or the GCC impact, especially in India.

Yes. I think just to close on the GCC topic and then I'll come to the hiring on the services side. As the momentum is still kind of going in, there is a lot of work around the project-based activities which are going on as far as GCCs are concerned, which is kind of an opening opportunity for service providers to walk in, help set up some of the centers of excellence. A lot of the GCCs are now trying to also house in some amount of the automation activities, data activities that they're trying to keep it within the GCCs. Having said, I think the hiring on the IT services side, we're not going to -- we don't expect it to ramp up anytime soon. I think it's been a muted growth on that front for a couple of quarters now, and we anticipate that this is what is going to continue. I guess where a lot of the focus is right now is a lot of the service providers are working on reskilling their own sets of employees right now, what they've hired in the last couple of years, particularly kind of preparing them for the Gen AI wave that's kind of expected to ramp up. And having said, I think they're also working on releasing on their own solutions and like Steve mentioned sometime back, they're also trying to implement them in-house and improve efficiencies. So that's where a large part of the focus is. So given all these nuances, we don't expect the hiring to increase.

Understood. And maybe just one last one and no conversation gets over without discussing AI. Great that you guys included that section this time and it was very insightful. Just wanted to understand a little bit on AI, right? I mean so there is -- you talked about the number of projects that have gone up and how providers are focusing around it. Just from an enterprise perspective and from the IT vendors perspective, how do you see the enterprises awarding contracting around AI when they are going to choose some of these vendors? Do you see some of the vendors coming out with differentiated ways of implementing AI and which vendors do you see doing it much better? I know you've talked about some of them in the slide. And almost close to $6 billion of revenue is quite encouraging. But I would love to understand how the overall contracting activity in AI is shaping up.

No, that's good, Rishi. And I think as I shared with you, I've got the new title within ISG as a Chief AI Officer. So I spent a lot of my time thinking and talking about AI these days. Let me put it in sort of 2 buckets, and I'll have Alex jump in on the second piece as well. In general, we see almost every service provider integrating AI, Gen AI into their solutions today, especially from a cost optimization or an efficiency standpoint. And we still expect quite a bit of cost savings associated with that, as Kathy mentioned. So we did the study last September, October. We were expecting to see sort of 30% to 60% savings, all broken out by different towers and everything as we see. What we're seeing right now is some hurdles, primarily on the legal and the regulatory side to make sure before we go there, we truly understand what the impacts could be, whether it's hallucinations or copyright or IP rights, trademarks, whatever the issues are, how the model is trained and how those -- the data that the model is trained on and who owns that data and the insights from that data is still very much being worked through. So we're seeing a lot of work sort of at the project. I would say it's beyond the pilot level. Again, as I said, this is only 6 quarters into this and the expectations are through the roof, but I think also the capabilities are through the roof. So it's balanced, but I think you're going to see that in many services deals on the cost side. And then you're going to see enterprises start contracting for outcome-based pieces especially as they move more to the revenue-generating components or the industry-specific components. But Alex has done a tremendous amount of research in this and has just created a -- completed a market lens report on it. Alex, do you want to share some of your insights?

Sure. So I mean, one of the things that is really obvious from the data we've gathered from enterprises is that by industry there's a lot of variation in where the focus has been for AI and the use cases that they're applying service providers to. Maybe one of the interesting things is across industry is the only commonality, is the application of AI to the analytics and BI programs generally. When we look beyond that, say, chemicals and energy has very different focuses maybe on more enabling their BPO functions, whereas BFSI is really focused on CX and healthcare and manufacturing, both really focused on ITSM enablement for AI, so they're leveraging service providers to support different things on the IT functions. But like I said earlier, there's a mismatch between what the IT department is currently leveraging IT service providers to support and what kind of the long-term enterprise demand is, which is to generate revenue and open new businesses. And service providers have struggled to really support their enterprise clients and doing that right now. And so we still see that as a little bit further off.

Yes. I'm good. Thank you so much for the opportunity. Let's open the floor for Q&A from the audiences.

Absolutely. Well, we've got quite a few teed up already. And just remember, if you have questions, just put them in the right on the screen, and we will get to them. So Stanton the first question, I think I'm going to throw over to you. And the question is, can you provide a current state of the demand for the human capital management software. What's the changes in that competitive environment and what do we see in that space?

Sure. So we did call that out specifically on the SaaS portion because HCM compared to other categories within SaaS, Software as a Service has actually held up really well during this tech downturn. It was up 3% year-over-year. That may not sound like much, but compared to many of the other segments within SaaS, it's actually been positive for most quarters. I think there was only one quarter during that SaaS downturn where HCM ACV was down. So that's very positive for that segment. I think if you look at what's happening within HR organizations, that's kind of a reflection of why demand remains steady in HCM. Continue to see a lot of centralization of HR due to cost pressure, and that could either be in an outsourced environment or in a share -- more of a shared services internal model. So a lot of centralization. And as companies centralize that, that lends itself more towards scale and then buying a single system of record. So I think that's benefiting it there. And then also just -- we've talked about this a lot on the insider Alex has is talent, access to talent, recruiting talent, retaining talent continues to be the #1 challenge or at least in the top 2 to 3 across pretty much every study, whether it's industry or service line or region that we do. So I think there's also a demand there for upgraded technology around human capital management to attract and retain talent. So in our view, that's really the shining star within SaaS is the HCM segment.

Just one other -- just improving the employee experience has been a really big push. And I think that may be another factor in HCM software is to really just improve the overall experience for employees.

Very good. The next question, Namratha, I'm going to give this one to you. It's really focused on BPO. What do you think drove the changes in BPO this quarter -- is this sustainable? And what do you see as sort of the shifts going forward?

Thanks, Steve. I think, yes, it was a nice little positive growth out there for the BPO market. We've spoken enough about the cost optimization through our call, and it continues to be the top priority across all of the deals. Now given this scenario, obviously, enterprises are leaning heavily on service providers and technology to kind of implement automation, to bring more process efficiencies and most importantly, also leverage automation to reduce the cost itself. Besides, I think there are also service lines like customer engagement, which also showed about 3% growth there, which have several use cases that are right for Gen AI adoption. And enterprises in -- we have noted this in some of our insiders index as well that enterprises have an appetite to spend for and explore the AI itself. And I think that's one of the other factors that will essentially fuel the growth as far as BPO segment is. And I think what it all means is also that this will drive immense amount of pressure on service providers. Alex just made a comment on the kind of pleasure that service providers have to live up to a certain level of expectations in terms of driving and driving value in ROI and not just become an IT partner but more in terms of thinking about what kind of business outcomes they will drive. So that's, I guess, in my opinion that's going to kind of drive growth and because there are some promising use cases and automation is really one of the key drivers and differentiators for BPO, that might continue to kind of maintain a little bit of momentum there.

Very good. And then Namratha, one more for you. And I think I know Rishi asked a similar question, but I'm just going to ask a click down -- what do you see more broadly for hiring and especially fresher hiring over this next period, maybe the next 2 quarters. That's been the talk of the media for some time, especially in the Indian markets. What's sort of your perspective there?

At least, I think, Steve, like I mentioned, at least for the next one quarter, we definitely don't see much of the fresher hiring or for that matter hiring across any of the levels to kind of pick up. Potentially, if the demand picks up, which is what we are anticipating, hopefully, in the second half of this year, if we see more deals and more AI kind of projects coming in. They will probably potentially see some amount of hiring, and that's where the reskilling and everything is going to happen. But at least for the next one quarter, we don't definitely see the hiring picking up.

Yes, Steve, I think just kind of piggybacking what Namratha said there, I think it's important. So obviously, we watch this really closely every quarter. We talk about the supply side of our industry that we are a people industry. That is what drives the IT services industry. So it's really important to stay on top of that as Namratha mentioned, we've talked about it inside. We've had 4 consecutive quarters now of decreases in head count, but that's primarily because of lack of backfilling for attrition. In my view, this part of the overall tech sector has been quite resilient during a broader tech slowdown, and we haven't really seen layoffs in the IT services industry. So we're watching this closely because that will be kind of an indicator. If we were to see that happen, if you start to think about what's happening with margins, as we talked about margins coming down, revenue forecast coming down. But in some cases, that's happening faster than the other. If you start to see potentially head count reductions that could be an indicator that demand is going to take longer to come back. But we haven't seen it yet, but we're going to watch it closely.

Yes. I think that's a great point, Stanton. And I think when we look at the whether it's layoffs or the pull back, we've certainly seen that across a lot of the tech industry. We've absolutely seen in the consulting and advisory business. We've seen a fairly big pullback there. And I think you're right, the managed services or the core service provider business has been fairly resilient to it, which speaks well for the market even as we reported a little down, again, still $10 billion of ACV this quarter, $6 billion almost of AI spend over the trailing 12 months. So there are some good things that are coming out of that. And I think we've got to continue to watch those signs. And Stan, let me stick with you just for a second. We saw a big uptick in travel transportation, hospitality. So we think about airlines, hotels, cruise lines. Are people back to traveling [indiscernible] is that driving that? What do I think the drivers on what's happening in the market?

I saw that question come in. So some of this is more of a market technicals thing because anytime that when we have this first quarter call, we're comparing a quarter to a quarter. And when -- because we're measuring annual contract value here, those swings can be pretty significant on a quarter-over-quarter basis. So that's the reason that we had -- that it's up over 100% ACV is because we had a pretty big swing in the first quarter. So I would say from a data and a technical perspective, the first quarter of 2023 was pretty weak. The first quarter of 2024 was strong. That's primarily the reason we had 100% increase in ACV. I would say, as we kind of look around the demand round up within the firm, the view is demand for technology remains flattish, fairly similar to what it was past -- in Q4, fairly similar to what we see in other areas, an expectation of increased demand in the second half and that travel firms continue to be cautiously optimistic.

Kathy, anything from you from the Americas on travel transportation. It is up sort of 30%. It looks like from this 5-year average. So it does feel like that sector has recovered and starting to spend more.

Well, obviously, travel is back and in full force. And so we are seeing some less resistance to not spend and to move forward. I think there was such a slowdown, obviously, from the pandemic, that's now passed. And I think we're just seeing some of the demand that they sat on for a while kind of trickle through and give us more increase in either renewing contracts, extending contracts, some new contract activity as well. But I think it was just because there was so much that was put on hold during the pandemic that we're now just seeing that release through into the market.

Excellent. No, that's good. So I think we've still got time for a couple more questions, everybody. And again, if you have questions, just send them here on the screen. So Stan, I'm going to throw this next one, probably to you and Alex. So this one has to do with hyperscaler incentive programs. It's more about what effect do we see on any SI project-based work. I know we don't necessarily just look at the incentive programs. But when you think about the increase in the hyperscaler business, are we seeing an equivalent increase in managed services business? And what should we expect to see for the rest of the year there?

Alex, do you want to take a stab at that?

Sure. So clearly, application modernization and migration to cloud is what service -- what hyperscalers are hoping to get extra capacity for when they're partnering with SIs. And what we see is compared to 2 years ago when we lasted a big cloud migration study and then looked at the ADM study we did back beginning of the year. There's been a shift away from kind of lift and shift modernization activities into the hyperscalers. And really enterprise is moving towards a SaaS first approach. We published an article on this about 3 weeks ago and really saw large increases in motivation to just rip and replace applications with SaaS where possible because we've seen a lot of this kind of migration and modernization work slowing down. So as far as what hyperscalers are going to do with their service provider partners, they really need to figure out a way to drive better economics about application modernization as things move into the cloud. And that means shortening the time to value without committing to kind of long-term high cost, high utilization of infrastructure resources from unoptimized applications.

Yes. I just believe that we're going to see a big play for Gen AI, and we talked about this earlier in the rip and replace, but also in the containerization strategy for moving workloads to the cloud. It's not just about building cloud native and starting from scratch and all the work. I think Gen AI, it's coding abilities, it's ability to give the story and the uses of the coated self is really going to accelerate that, which I got to believe is going to help drive even more efficiency on the app modernization front.

And Steve, I'll just add one more quick point on this. As I look at the question, there's also kind of a part of the question around new incentive type models rather than paying upfront more for outcomes upon successful project delivery. My sense is that the number of questions and inquiries coming in around output or outcome-based contracting models or what we're seeing in the market, that's increased pretty significantly over the past 6 months in my view. And I'll provide the same answer here that I do every single time. It's just, to me, that depends so heavily on the maturity of the enterprise. Their ability to both release control to be able to move away from more of a time and materials approach to more of a fixed price approach or even using a pod to go to build a new product, right, that requires maturity, not just in the organization, but in the technology of the enterprise to be able to enable a service provider to deliver in that way. I think that's going to apply whether it's for a hyperscale or channel or in BPO or to go build a new app. It just depends so heavily on the maturity and willingness of the buyer, both their organization and their underlying technology platform that enables that outcome.

Yes, that's good. All right. So I'm going to take the softball question, guys, and then Kathy, I'm going to give you the last question. So I'm going to tee one up for you on what's the broader impact on the customer experience across major verticals. But the softball question that I'm going to take is are we seeing providers leading with Generative AI in the sales process. Unequivocally, yes. As a matter of fact, you can't get into a meeting and I've got to count down now. It's usually about 4 minutes before somebody mentioned AI for Gen AI. And then it's a conversation about what does it mean and how do we go forward. As I've talked a lot over the past year, we're at the very early stages of AI. It's really the Cambrian explosion. It's the democratization of AI after chat GPT was launched. Everybody from the CEO, to the newest analyst that's just been hired into an organization is trying to figure out how to really do it to make themselves more productive, make the organization more productive. And it's being embedded in so many solutions. As we said, we're not seeing it completely on the pricing side yet, but we fully expect to, and we think that will flow through. So that was the easy soft ball. Kathy, I'm going to end with you. And the question is, what are the prospects that you see for customer experience in BFSI, healthcare, travel and transportation. And do you see a difference on customer experience, whether it's the customer employee engagement between BPO solutions or any other areas that are accelerating.

Very big question. But when I think about customer experience or even employee experience, and I think the supplies across industries, actually, it is meeting the customer, the employer, whoever the customer may be where they are. And I think where customer experience fails is assuming what the user or the customer wants. And the people that are going to be successful in really bringing customer experience in a successful way is thinking about what their users need and what they want at the time. So I'll give you an example. We all get e-mails from [indiscernible] you may do business with or they see you on the web, and you get inundated with them. And they send you lots of different touch points and things. Well, maybe I don't want all those touch points. Maybe I just want to touch point or maybe I want specific touch points. So I think that the industries that can crack bringing the customer the experience that they specifically want in a unique and individual way will win instead of being broad-based customer experience, just in general, bringing it to their -- either their users, their customers, whoever it may be. I think it's going to be the individualization of that customer experience. And I think AI and Generative AI is going to have a big impact on that.

Excellent. Well, thank you, everybody, for your expertise and insights and Stanton over to you to close this out.

Awesome. Thanks, Steve. Rishi, big thanks to you and your team for hosting the call today. As a reminder, you can access a copy of the slides and the regional leader boards that we didn't show you today out on the ISG website. So we'll publish a summary of today's call on the Index Insider. So that will be in your inbox tomorrow. I encourage you to forward it to your colleagues if they're not yet subscribed. Thanks again, and we'll see you on the second quarter call on July 11.