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Article24 Jan 2022

IT Services: The Transformation Imperative

In IT services, growth is all about digital transformation. In a report by Citi’s US IT Services Research analysts, Ashwin Shirvaikar and Ryan Potter, they say that many IT service providers are making sure that they stay intensely focused on or pivot toward these transformation efforts.

Citi’s Research analysts believe that the only source of IT Services growth is the enablement of enterprise digital transformation.

Digital transformation is more widespread and enterprise-wide than in 2021 – and accordingly, IT services providers continue to pivot to be best positioned to service this demand.

The corollary to this is that there is a ruthless whittling down of all initiatives that are not digital transformation related.

Following are some points to keep in mind, according to Citi’s analysts:

1. During 2021, two factors benefited revenue growth – the bigger one being that digital transformation was happening at an accelerating pace. But there was a second benefit due to easier comps stemming from the drop-off in demand experienced starting in March 2020. Obviously, in 2022, the latter benefit does not exist, suggesting a drop in the actual revenue growth rate. Citi’s analysts believe that this is likely to be muted due to the broader strength of the enterprise digital transformation push.

2. A recurring investor question relates to the duration of digital transformation. Citi’s analysts have no doubt this is a multi-year event, simply because most enterprises were so heavily loaded with technology debt and the penetration of cloud, automation, mobility, etc. was quite low.

3. Digital transformation as a concept is not new, of course. In fact, Citi’s analysts have written about it for the better part of a decade. But it was generally incremental. An important change is that it is now enterprise-wide in more and more corporations and is a global phenomenon as well.

4. Price sensitivity is limited in many of these transformations. This is partly due to the recognition that such transformation leads to business advantage (often sustainable), partly as a result of fears of disruption or disintermediation if rapid action is not taken and partly a known supply crunch that is affecting every participant in the industry.

5. There is recognition that digital transformation is not just about the IT infrastructure. What’s important is the underlying process and data as well.

6. Digital transformation started off as small technology projects, and the initial phases were not vertical-specific. But some of the extensions of this work are evolving to highlight vertical differences – Citi’s Research analysts believe that domain knowledge will become more important through this year and next. A parallel is the growth of vertical SaaS solutions, which interestingly are one element of verticalized digital transformation. Other elements include solutions that matter to particular verticals. For example, the

automotive industry may have more focus on digitally enhanced vehicles, mobility services, and green tech; retail continues to improve on the omni-channel experience, and financial services companies are scrambling to compete against FinTech companies, which provide a personalized user experience, on-demand services, and better decision-making capabilities to seek out what the consumer wants.

7. New emerging technologies and market trends have also altered how users interact with brands and have forced businesses to redefine engagement models and customer experiences. This, in turn, drives demand for specialized engineering and creative talent to rapidly design customized solutions. This demand is enhanced by the general shortage of talent in these skillsets globally as well. The heightened interest in customer experiences and journeys creates some very good opportunities in the sector also.

8. Citi’s analysts are looking for a steady increase in the scope of what digital transformation covers. Already, a few firms are beginning to talk up experiences via the Metaverse.

9. The digital transformation space can be viewed as large and growing and not a zero-sum game. But, anecdotally, enterprises tend to name a small number of digital partners (often one or two) that are brought in based on a perception of value that they can deliver, while in outsourcing, historically there could be a long list of vendors that competed against each other based on cost and price.

 

Digital Service Pure-Play Valuation Analysis In a different report, Will 2021 Stock Performance Trends Continue in 2022?, Citi Research’s Ashwin Shirvaikar and team analyzed the sector’s 2021 stock performance, with the key takeaways as follows:

  • With limited exceptions, stock performance followed cumulative operating performance (good revenue growth, good earnings growth, good performance against those expectations) and simplicity of messaging (digital = good; everything else = not so good).
  • Conversely, not meeting prior expectations or changing the message was brutally punished.
  • Digital transformation opportunities are in business process outsourcing (BPO) as well as IT Services – but BPO tends to recover more slowly than IT Services, and Citi Research expects higher growth in 2022 than in 2021 for some names.
  • One big question regarding the IT Services sub-sector is its perceived high valuations. In general, Citi Research’s view is that the currently heightened growth rate should continue, with the caveat of the benefit of “easy comps” during 2021.

So, in IT services, digital transformation is only becoming more vital. For more information on this subject, please see US IT Services - There Is No “Plan B” – Digital Transformation Still the Only Game, publishing January 14, 2022.

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.

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