IT Services in the Wake of AI: The Winning Models to Build and Invest In

For 20+ years, businesses described as "IT Services partners" and "Digital Transformation consultancies" have been a key pillar in investor portfolios, generating very strong returns overall - though there has been increased variation in individual asset performance post-COVID as the sector has matured.

And now, in case you missed it, "AI" is a thing. To dramatically summarise the opportunity vs. bubble debate: despite ChatGPT achieving breakout success over 3 years ago, the reality is that there has not been a revolution (yet) - spend is being diverted, trials and proofs-of-concept invested in, but the world hasn't quite turned upside down (yet) and underneath the websites and marketing, most (but not all) IT Services businesses look relatively similar to what they did 5 years ago.

Nonetheless, AI will be incrementally adopted in corporates, and so the classic question from investors when looking at IT Services assets is: "How will this business be impacted by AI?"

Our approach to answering that looks at five underlying trends impacting what we look for in IT Services businesses today and going forward:

1. The categories of IT spend by end-customers are rapidly changing.

There is a big mix shift: areas most directly exposed to “AI” (and underlying data) are capturing share. This covers, for example, the building/implementing of AI-enabled applications, as well as work to develop back-end infrastructure, support data readiness and develop data strategy. Based on our discussions with CTOs, areas of spend related to Data & AI are growing ~20%. On the other hand, some more traditional areas are only growing ~5%, as spend is pulled away towards Data & AI.

Read that again as this is simple but huge - under the hood of the "IT Services" label, you can now be in a 20+% through to 5% or lower market.

2. Within a product IT category, some software vendors have developed winning propositions, while other software vendors are lagging.

Whether it's ERP, CRM, Accounting, Cyber or any other sub-sector, all the key vendors are racing to build out their AI offerings. Some are ahead; others are behind.

For vendor-focussed transformation partners, the strength/trajectory of the AI offering is increasingly critical to assess.

3. AI is disrupting historical approaches to differentiation of IT Services providers

Some old differentiation models are being put at risk. For example, independent, specialist IT Services businesses would often differentiate themselves from the Global System Integrators (GSIs) through boutique service and agile/tighter scopes.

But are GSIs now able to deliver projects more nimbly? If a firm successfully differentiated based on end-vertical focus, will that still be as powerful now - have in-house “accelerators” been displaced by AI-enabled software?

AI can enable new differentiation models - does a set of AI capabilities, alongside traditional tech. knowledge, make a unique combination versus a legacy competitor set?

4. In the world of AI, customers need continuous advisory relationships.

To oversimplify: in the old world, CTOs know what they needed, and bought in specialists to deliver lumpy implementations. Now, there's a lot less clarity on the future. Customers are seeking more agile, incremental, modular implementations and enhancements. Businesses that can give their clients strategic roadmap advice, and offer modular, agile implementation work scopes, are much better positioned.

5. Some delivery models are more "at risk" from AI-enabled automation than others.

The biggest concern is that the scope, and therefore value, of projects significantly reduces as you need fewer billable days to deliver the work (AI accelerates the work).

Overall, this is less of a risk if:

• The nature of the work has high client-context dependency and engagement. Time understanding business processes, iterating with key users and providing wider recommendations and advisory work cannot be automated.
• The work is highly bespoke. Off-the-shelf "big bang" implementations included a lot of repetition (which even pre-AI was getting eaten by in-house accelerator IP). Big partners can accelerate and streamline this with AI, whereas highly bespoke work is less susceptible.

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For what it's worth, we often get asked about the impact of pricing models. There are a lot of hypotheses and headlines around the need for tech service providers to shift from labour-volume models (either T&M or fixed price) to alternative models, such as value or other output based pricing. This might happen, maybe. But it's not happening today, and it's not the thing that's driving customer selection or financial performance of individual tech services business. IT Services businesses should be fast-followers here - any IT Services provider who leads with a message about winning in AI-world based on their pricing model is missing the important stuff!

The largest global system integrators and outsourcing partners (think Accenture, Capgemini, Wipro, Infosys, and others) are struggling - in large part because of Points 1 and 5 above. Historically, these businesses were overweight in core, non-AI, systems (think big ERP, CRM and other multi-year projects) and offered blended offshore models (lower client dependency, more off-the-shelf). These businesses are now investing rapidly through M&A in data/AI specialists, and are facing the greatest headcount/cost reductions in their offshore hubs.

But the opportunity for specialists remains strong. IT Services businesses with strong Data & AI practices (or backing vendors with strong AI roadmaps), with the ability to proactively take clients on the AI journey (strategic, not just technical advisory, and more modular projects) and where the current delivery model is primarily onshore (a proxy for client context dependency and bespoke scopes) are strong bets. And underneath it all, a flexible and open-minded management team is non-negotiable. We don't know what we don't know. Openness to that, and flexibility over a 5+ year journey, is essential.

We can easily get scared of IT Services business and say "all bets are off". But not investing in the entire sector is unrealistic. It's pretty clear that overall corporate IT budgets aren’t shrinking, but simply evolving to best capture the potential benefits from AI. This isn't a sector to move out from, but instead a sector where our thinking needs to evolve.