This is Stanton Jones with what’s important in the IT and business services industry this week.
If someone forwarded you this briefing, consider subscribing here.
Managed services deal durations continue to increase. Will expectations of future AI savings reverse the trend?
As you can see in this week’s Data Watch, average contract durations have increased significantly since 2022. That may sound counterintuitive given how quickly AI is improving. After all, committing to a longer agreement could mean accepting savings today that look less attractive tomorrow, as models improve and providers find more ways to automate delivery.
We’re seeing many enterprises weigh this risk today. But they’re also balancing that risk with the urgent need to reduce costs in order to improve margins.
This helps to explain why contracting activity has remained steady in the IT services sector. But getting to – let’s say – a 40% reduction in the cost of an enterprise application portfolio requires a lot of change. Applications and integrations have to be rationalized. Manual work needs to be automated. Processes have to change because of that automation.
Better models can certainly help, but at the end of the day, you need people to implement this level of change. And you need time.
So, to better understand why an enterprise would commit to AI-driven savings today while potentially missing out on more AI savings tomorrow, let’s look at it through the eyes of someone with a lot of skin in the game. Take the CIO, for example.
Put yourself in that person’s seat: I’m under pressure to dramatically lower costs over the next two to three quarters. But we’re already running incredibly lean. My budget is flat, and there’s no spare capacity to change the work. Even if there were, we’re missing some of the skills needed to implement the new tech stack and the new way of working.
Now a provider offers to reduce your application costs by 40% and fund the transformation. They also agree to engineer the deal so that a big portion of those savings is delivered up front, helping you meet your budget targets sooner.
The caveat? The agreement will last around six to nine months longer than the previous apps agreement to give the provider more time to recover its investment. You can see why that’s appealing. The CIO gets savings now, along with the resources to make changes the organization cannot readily make itself.
There’s still a risk that future AI improvements could produce savings far beyond the committed 40%. But that assumes the provider will be able to quickly translate a better model into cheaper service delivery. And of course, waiting itself has a cost when the savings are there to be had.
So, back to the original question: will expectations of more AI savings reverse the trend toward longer contracts? We’ll know more after we have a full year of data from 2026. But what we do know is that as long as cost pressure remains high, service providers will be playing a major role in the financing of these multi-year, cost-focused transformation programs.