Volatility Ahead After a Resilient First Quarter for the IT and Business Services Sector

This week has been a heck of a roller coaster ride.

At the start of the week, the U.S. administration imposed tariffs on goods from America’s trading partners around the world, many of whom reciprocated with tariffs of their own. Stock markets tumbled immediately.

Days later, the administration paused the tariffs on most countries for 90 days. Stock markets rebounded. But the sudden about-face leaves a long trail of uncertainty. No one knows what policy change will be announced on any given day, making businesses cautious about spending on current projects or planning new ones.

Because changes in U.S. trade policy took effect after end of the quarter, they had little impact on the performance of the IT and business services sector in Q1. But already we are seeing industries scrambling to adjust, as they did during COVID and in the global financial crisis of 2008. In our 1Q25 Global ISG Index™ webcast this week, we weighed in on what the volatility portends.

But first, Q1. The global IT and business services market showed continued resiliency in the first quarter. The annual contract value (ACV) of the combined managed services and as-a-service markets grew 18 percent year-on-year and 2 percent from the prior quarter. Robust AI activity, renewed momentum in cloud transformation and hyperscaler growth are positive signs of the long-term health of the market. Global capability centers (GCCs) are accelerating product development and hybrid delivery adoption as enterprises remain focused on optimizing cost and productivity and modernizing platforms.

ITO had a strong first quarter; its ACV was up 12 percent year on year. Beginning with this Index, we are separating out engineering services from BPO. In Q1, ER&D generated $1.1 billion in ACV, up 42 percent, and now has five consecutive quarters of double-digit growth under its belt. BPO, meanwhile, dropped nearly 40 percent year on year, with all areas down by double-digits against a strong first quarter last year.

Regionally, the Americas’ $5.3 billion in managed services ACV edged down less than a percentage point from last year but this nevertheless marked its third decline in the past five quarters, demonstrating the choppiness of the sector. Small deal activity fell year-on-year as it has in three of the last four quarters, an indication of discretionary spending pressure.

EMEA posted $4.4 billion in managed services ACV, a 13 percent gain from 1Q24. Asia Pacific’s $777 million in ACV marked a 26 percent drop, reversing a four-quarter trend of year-on-year growth that averaged 31 percent.

Infrastructure-as-a-service generated nearly $14 billion of ACV, up 34 percent year on year. Hyperscalers are investing heavily in hardware to meet AI demand. However, they are facing supply constraints for GPUs, not to mention tariffs on imported capital goods to build their data centers.

Software-as-a-service generated a record-breaking $4.5 billion in ACV and had its fourth consecutive quarter of year-on-year growth. Providers paint agentic AI as a silver bullet to improve performance and lower costs, but an enterprise’s ability to adopt the technology depends on the complexity and readiness of its data.

In our 1Q25 webcast, we laid out sector-specific pressures in financial services, manufacturing, travel and transportation, and life sciences. Large capital-intensive initiatives, such as SAP S/4HANA migrations are particularly exposed and may lead SAP to reconsider its 2027 end-of-support deadline.

Recession fears loom large. In addition to the on-again-off-again tariffs, markets are contending with geopolitical tensions and evolving regulations. Our 2025 forecast covered two tariff scenarios — transitory and long term. If the tariffs are short-lived or stabilize by midyear, enterprises may have more confidence in making strategic decisions and moving ahead with projects now on hold. If so, we expect the as-a-service market to grow by 18 percent in 2025, unchanged from our January forecast, and managed services to edge up 1.3 percent, down from our previous growth forecast of 4.5 percent.

If the disruption from tariffs lasts into the third quarter or beyond, our outlook turns more bearish, especially if compounded by immigration enforcement and retaliatory digital services taxes from our major trading partners. In that case, we expect as-a-service to grow by only 15 percent, and managed services to shrink to negative 2.4 percent growth.

One thing’s for sure: the only thing certain at the moment is uncertainty.

So, we remain cautious, but not pessimistic. The signals from Q1 are fundamentally strong. The shift we’re seeing is not one of declining demand, but one of delayed commitment.

To get a fuller picture of current market dynamics, view the 1Q25 Global ISG Index™ webcast replay, presentation slides and press release on our website.

While you’re there, we invite you to sign up for our weekly ISG Index Insider briefing and register for our 2Q25 ISG Index call, set for July 10. Until then, hang tight. The ups and downs of this roller coaster ride are likely to continue.