They say the past explains the present, and if that’s true, what insights might we glean from history to prepare for where high interest rates could take the economy? That’s one of the topics we explored in our 3Q23 Global ISG Index™ webcast this week, reporting on the state of the global managed services and as-a-service (XaaS) markets.
First, let’s start with the present: In the third quarter, the annual contract value (ACV) of the combined global market (managed services and XaaS) came in at $23 billion, down 3 percent. It was the fifth consecutive quarter the market has declined year on year, but the decline was smaller this quarter, suggesting the market may have hit bottom and may soon begin to rise. Year-to-date ACV came in just shy of $70 billion, down 7 percent from the prior year. The last time a nine-month period came in negative was in 2015.
Managed services ACV, up 11 percent to a record $10.3 billion, exceeding $10 billion for only the second time in a quarter, eclipsing the highwater mark set in the second quarter this year. In an uneven tech market roiled by rising interest rates, managed services has proven remarkably resilient. XaaS ACV, meanwhile, fell below $13 billion for the quarter, a 13 percent drop from the prior year.
XaaS has steadily declined after peaking at $16 billion in 1Q22. The segment generated $40 billion of ACV year to date, falling 15.5 percent from the prior year. This is the first time XaaS has shown a year-on-year decline at the nine-month point. Its market share has shrunk to 57 percent of combined market ACV, down from 62 percent last year.
The Americas combined market ACV, which had dipped below $11 billion last quarter, surged above $12 billion this time. Year on year, it was down less than a percentage point but it was still the fourth time in the last five quarters the Americas fell into negative territory.
Managed services in the Americas saw robust growth in Q3, up 25 percent, to $6 billion of ACV, fueled by a record number of new scope awards along with strong activity in restructured deals. Energy and Healthcare/Pharma, the “defensive” sectors, outdid themselves year to date and offset the declines in a couple of the larger sectors, Financial Services and Manufacturing. XaaS generated more than $6 billion of ACV for the quarter in the Americas, but that was down 17 percent year on year, and it was the third consecutive double-digit decline in a quarter.
The combined market ACV in EMEA, just shy of $7 billion for the quarter, fell for the third time in four quarters. Managed services ACV of $3.7 billion fell back to its typical level. The U.K. led growth with its third consecutive billion-dollar-plus quarter, reaching $1.7 billion of ACV. XaaS has fallen steadily in EMEA since the start of 2022, sitting at just over $3 billion this quarter.
In Asia Pacific, combined market ACV for the quarter remained above $4 billion as it has for the past 18 months. Managed services, which had been running hot in the region over the past year, paused this quarter and fell below $800 million after posting million-dollar-plus ACV for two of the past three quarters. ANZ soared 54 percent, and India nearly doubled its ACV. Quarterly XaaS ACV has stabilized between $3.3 billion and $3.5 billion this year. Though this quarter marked the fifth consecutive year-over-year decline, the decrease was much less than in prior quarters. The fourth quarter this year will be against a much easier compare.
Globally and in the three regions, megadeals drove managed services growth. Year to date, 27 megadeals were signed, totaling nearly $5 billion of ACV. On the other hand, small deals dried up. Whether that’s due to a hesitancy among enterprises to spend on discretionary purchases, or whether the small deals are getting rolled up into larger ones, time will tell.
A recent ISG survey of more than 300 large enterprises confirmed what we’ve noticed anecdotally — the proliferation of Global Capability Centers, mainly for reasons of cost optimization or to access talent. In our 3Q23 Index webcast, we talked about the three archetypes of GCCs based on how businesses use them. It’s interesting information, and you can view it in a replay of our webcast.
Now, back to the future: Yes, interest rate hikes are necessary to curb inflation, but historically, that correlates to lower tech spending in BFSI a year later. Higher rates tend to benefit BFS firms, but they’ve been reluctant to spend during this cycle of repeated interest-rate hikes. As tech spending slows, enterprises reduce outsourcing and rely more on existing in-house talent. That’s why we’ve seen a pullback in combined market ACV thus far this year. Fortunately, we seem to be nearing the end of rate hikes.
Even so, energy prices and a strong dollar remain concerns. But given the strength in managed services and focus on cost optimization, we’ve raised our growth forecast for managed services to 5.4 percent for the year. XaaS is more complicated. While the software-as-a-service market is gaining strength, the cloud market remains under pressure, so we’re leaving our 2023 revenue forecast for XaaS at 11.5 percent.
To get a fuller picture of current market dynamics, view the 3Q23 Global ISG Index™ webcast replay, presentation slides and press release on our website.
For a quick video summary, I encourage you to watch the latest edition of “ISG Index™ Headlines” on the same page or on YouTube.