Hello. This is Stanton Jones and Sunder Sarangan with what’s important in the IT and business services industry this week.
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What You Need to Know
Headcount growth remained flat again in Q1. However, revenue growth slowed. Is that because of weak demand, the effects of AI not yet kicking in, or both?
Data Watch
Background
It’s hard to believe, but it’s been three and a half years since ChatGPT was released. That date back in the fourth quarter of 2022 was important for a lot of reasons, one of which is that it gives us a clean inflection point on which to measure the impact of AI.
That’s why we used it as the starting point for our recently released ISG AI Index and why we’re using it again today for our analysis on how AI is (or isn’t) impacting the IT and business service sector. Specifically, the relationship between people and revenue.
The idea here is that LLMs will make service providers more productive, so they can produce more for the same or less. In theory, that should start to decouple revenue from headcount.
As you can see in this week’s Data Watch, headcount in the sector has stayed relatively flat for the past year while revenue has been slowly increasing. In fact, last quarter we saw the most significant divergence between revenue and headcount growth in more than three years.
Then, this quarter, revenue growth dipped.
The Details
- Revenue growth in the sector is up 9.4% since 4Q22 but saw a sequential decline in 1Q26.
- Headcount growth, meanwhile, is essentially flat over the same period.
- Other metrics like attrition and utilization are broadly in line with 4Q25.
What It Means
One of the challenges of measuring a market is that there is almost never just one factor impacting conditions. In this case, there are two big ones: the economy and AI. We’ve talked at length about how the extreme degree of business uncertainty is driving strong demand for cost reduction. That can be a net positive for the IT services sector because it drives more outsourcing, but it can also be a negative because, when discretionary spending is under pressure, we see less spending on consulting and project work.
That creates a murky demand picture for service providers, which means they – just like their clients – hold off on hiring. Which is exactly what they’ve been doing over the past few quarters.
But isn’t AI impacting the sector as well? Of course it is, but it’s harder to quantify. And that’s because the expectations of AI are causing providers to step back and rethink the supply side of the equation. Do we still need thousands of entry-level hires? How do we reskill our existing employees? What does a human-plus-agent delivery model actually look like? These are the questions many providers are asking today as they assess their client portfolios and review their pipelines.
So, in our view, the flat headcount and gradually rising revenue over the last few quarters is more about muted demand combined with relatively low attrition and high utilization levels than it is about AI breaking the traditional relationship between people and revenue.
As to why revenue growth dipped in Q1?
That’s probably best answered by revisiting what we said last quarter: “we’ve seen similar swings – in both directions – like this in a single quarter before.” Given that we’re working with two variables here – the economy and AI – we’re likely to have lots more of these swings before we can really understand if AI will start to break the connection between revenue growth and headcount growth in the sector.
About the authors
Stanton Jones
Stanton helps enterprise technology leaders, IT service providers and buy- and sell-side professionals make sense of the global IT services sector. Stanton's weekly briefing - the Index Insider - is read by thousands of industry stakeholders each week.
