Morgan Stanley Predicts A Big Slowdown In Outsourcing In 2013

Outsourcing measures that have allowed American corporations to scale back on labour costs over the past several years may be set for a big “surprise” slowdown, according to a new report from Morgan Stanley.

Morgan Stanley IT services analyst Katy Huberty and chief U.S. equity strategist Adam Parker introduced today a new model of leading indicators they say displays a significant correlation with quarterly revenue growth in the outsourcing industry.

As the chart below shows, revenue growth in outsourcing hasn’t faced meaningful headwinds since the financial crisis in 2008.

Yet headwinds may re-emerge. Here is what the model predicts for the rest of this year and next year:

MS outsourcing

In the report, the Morgan Stanley team writes, “Outsourcing growth may be less defensive than many believe with growth decelerating through 1H13.”

Furthermore, the results of the new model has led Morgan Stanley to slash revenue and profit growth estimates across the board for players in the outsourcing business including IBM, Dell, and Accenture.

The analysts say recent rumblings from HP lend some credence to the projected slowdown:

At HP’s analyst day in early October, management noted that a runoff of four key clients is pressuring Outsourcing revenue. While some of HP’s issues may be company-specific, an overall trend toward in-sourcing is worrisome. For example, we know that GM, one of the four clients, which spent an est. $600m with HP annually (~2% of HP’s Services sales) has decided to bring much of its IT work in-house.

This could be another sign that profit margins are set to drop from record highs as corporations run out of juice to squeeze from their cost structures.

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Note: below are the inputs that comprise Morgan Stanley’s model.

Morgan Stanley outsourcing model