TPI Index Spotlight — What a Difference a Decimal Makes: Why Contract Durations are Trending Shorter

TPI Index researchers recently found that, so far this year, contract-duration averages — which had recently hovered around five years — fell to 4.85 years. That tiny difference can have a big impact. We explored the topic during today’s 2Q12 TPI Index call.

It’s strange how such a small statistic can take you down the path of finding out a good deal more about the mechanics of the Broader Outsourcing Market (contracts >$25M) . . . no pun intended!

Take that 4.85 contract duration average in the first half of 2012 — if the current market awards had durations of 6.5 years, as they had from 1999 to 2000, the total contract value (TCV) for 1H12 would have yielded $57B rather than $41B, a 38% upside difference in total contract value .

As we analysts became carried away by what a difference a decimal makes, we found a pattern related to contract durations throughout outsourcing industry history. During more than a decade, there have been a series of plateaus, followed by drops, in contract durations since 1999. Every few years, the average contract durations retreat  . . . from about 6.5 years in 1999-2000 to the recent 4.85-year average.

If this pattern holds, the market may be moving toward another duration drop between 6% and 9%, bringing average contract duration levels much closer to the 4.5-year mark.

Of course, few if any contracts will be signed at 4.5 years in duration, but we would expect to see more contracts signed of lower durations and fewer of higher durations. That’s exactly what has happened. Contracts of less than five years’ duration are becoming more prevalent every year, while contracts greater than seven years in duration make up an ever-decreasing share of the market.

Contract durations are migrating downward for several reasons:

  • Clients do not want to commit for as long in their agreements, and providers more often comply in order to seal the deal.
  • Both parties are more outsourcing savvy and have found ways to achieve desired results more efficiently. Term is less of an initial issue today because contracts are so often restructured after about three years.
  • And newer contracts with cloud in scope are shorter in duration than traditional managed services deals.

We found diminishing durations among many categories of contracts and across all TCV bands:  for both ITO and BPO contracts . . . for contract awards above and below the $200M TCV mark . . . and everything from  the first few contracts a company signs to restructurings.

As BPO, restructurings and smaller deals are expected to make up an increasingly larger proportion of awards coming to market, we can expect the average contract duration to continue to decline.

 


Have you experienced the same trends we’ve noted at your organization? Or something different? Please share your thoughts about contract duration in the comments section below.