Cloud economy cools, but IT services deals continue

Cautious customer spending is slowing the growth of the broader cloud market. But IT service providers continue to pursue M&A for scale and skillsets.

Cloud growth shows signs of slowing amid the economy's mixed signals. But IT service providers are nevertheless preparing for expansion over the long haul.

Two reports last week point to a cloud economy that's looking a bit more vulnerable. Canalys, a market research firm based in Singapore, reported that the annual cloud growth rate has fallen below 30% for the first time. The company said worldwide cloud infrastructure services spend grew 28% year-over-year, reaching $63.1 billion in the third quarter. Canalys cited the negative effects of inflation and "companies responding to market uncertainty by reducing spending."

Gartner, meanwhile, forecasted public cloud services to grow 20.7% in 2023, which the company pointed out is higher than its 18.8% forecast for 2022. However, the company said cloud spending could decrease if overall IT budgets shrink. Gartner's current prediction calls for 5.1% growth in worldwide IT spending next year.

Q3 financial results reinforce the notion of a cooling market. AWS late last month reported its lowest growth rate since Amazon began breaking out separate financial data for its cloud business in 2014. AWS posted a Q3 revenue uptick of 27.5%, compared with a 33% revenue increase in Q2. The company cited customer cost cutting.

Cloud services investment continues

Against that backdrop, services providers continue investing in cloud professional services businesses.

Cognizant, an IT services company based in Teaneck, N.J., said last week it will acquire the professional services and application management practices of OneSource Virtual, a company that provides services around Workday's SaaS ERP platform. When the deal closes -- expected to happen by the end of this year -- Cognizant will gain nearly 400 employees. They will join Cognizant's Collaborative Solutions team, where the company's Workday practice resides.

The transaction is a vote of confidence in the cloud and its growth prospects. "The reality is we continue to see tremendous demand across platforms in general," said Rob Vatter, executive vice president of Cognizant's Enterprise Platform Services.

In the Workday ecosystem, customers continue to modernize core business processes such as finance, human capital management and payroll despite the macroeconomic trends -- in some cases, because of them, he noted. Workday is looking at 21% to 22% growth, he said, noting that Cognizant's Workday practice tracks with that rate.

Enterprises, however, might not view initiatives beyond their essential functions with the same enthusiasm.

"Where I see some of the headwinds is on other, discretionary projects that aren't touching these core business processes -- the nice-to-haves versus the 'I need these,'" Vatter said.

IT services outlook graphic
The broader IT services market seems set for expansion, although economic headwinds could affect non-core projects.

66degrees, a Google Cloud Premier partner with headquarters in Chicago, is also seeing steady demand for cloud services. The company last month merged with Pandera Systems to bolster its Google Cloud data analytics business.

"We don't see that need ever going away, even if there was a short recessionary period or an extended one," said Matt Kestian, CEO at 66degrees. "Data and analytics [are] at the center of every business decision that's made. We're not seeing severe headwinds around people holding back on the cloud space. They're basically saying, 'This is part of our core business. This is how we get advantage."

Pandera Systems, based in Orlando, has been in the data analytics market for more than 12 years and made a "hard pivot into Google Cloud" about three years ago, Kestian noted.

Market drivers for IT services

The IT services market is expected to grow 7.9% in 2023, according to Gartner. The company's forecast cites cloud demand, IT skills shortages and accelerated digital transformation as boosting demand.

Confidence in customer activity has cloud professional services providers pursing acquisitions to expand employee rosters and grow skill sets. This is particularly important in the Google Cloud market, where service providers tend to specialize in niche capabilities, Kestian said. The goal is to make the combined company greater than the sum of its parts, he noted.

The reality is we continue to see tremendous demand across platforms in general.
Rob VatterExecutive vice president of Cognizant's Enterprise Platform Services

Kestian's company was built through mergers and acquisitions: 66Degrees came together in 2021 through the merger of Cloudbakers and Qwinix Technologies, a transaction backed by private equity firm Sunstone Partners. The recent Pandera Systems merger lets 66Degrees expand from 300 to about 500 employees, adding 150 data and analytics specialists.

Prior to the merger, 66Degrees focused on infrastructure, application modernization and workspace collaboration but maintained a small data and analytics footprint, Kestian said. Pandera Systems contributes visualization, data advisory, data engineering and data warehousing skills as well as AI and ML project experience in areas such as digital concierge.

"Where they were strong, we were less strong," Kestian aid. "And where we were strong, they were less strong. Pandera brings the skills and scale around the data and analytics."

Speed and scale central to acquisition strategy of IT providers

Scale also ranked among the factors behind Cognizant's acquisition of OneSource Virtual. Workday maintains a relatively closed ecosystem that requires a lengthy certification process for partners, Vatter noted. So, service providers might find acquisitions the quicker route to expanding a Workday consultant roster.

Another attraction: OneSource Virtual's certification regimen lets it participate in Workday Launch, a program for helping customer rapidly deploy HCM systems. Cognizant will have access to that program once the acquisition closes.

In addition, OneSource Virtual provides methodologies and accelerators that support Workday Launch. Cloud professional services firms are rolling out accelerators to meet customer demand for faster turnaround on digital transformation projects.

OneSource Virtual's intellectual property will help Cognizant get its Workday customers "up and running a lot more rapidly than we would have before," Vatter said.

Geographic scale is another dimension to the deal, as OneSource Virtual operates in the United Kingdom.

The increasing complexity of cloud projects also fuels demand for scale and skillsets. The need to integrate systems in hybrid deployments influences technology alliances as well as acquisitions. BeyondID, a managed identity services provider in San Francisco, earlier this month obtained Diamond partner status for Okta's identity platform. The Diamond level -- the top specialization tier for Okta service delivery partners -- reflects the ability to take on complex implementations, according to BeyondID.

Arun Shrestha, CEO and co-founder of BeyondID, cited the growing need to combine an identity platform with deployment expertise to tackle the "complex use cases of migrating from the legacy stack and integrating with systems of all types of on-prem or cloud."

More deals in cloud professional services?

Cloud professional services transactions have been plentiful in 2022. But will the deal-making pace continue next year given economic uncertainty?

In the Google Cloud market, at least, the trend looks set to continue. Kestian likened the Google partner ecosystem to what he saw with Microsoft around the 2009-to-2017 timeframe. "You had individual niche companies and some of the larger players looked at those, or some of the individual private equity firms looked at those, and said, 'Well, how do we bring these together?' It's definitely going to be a market consolidation as Google matures."

Similarly, Vatter said he believes rollups will continue on the services side, noting the abundance of boutique firms in cloud partner ecosystems.

Jaret Chiles, global vice president of client services at DoiT International -- a multi-cloud software provider and MSP based in Santa Clara, Calif. -- suggested the economy is influencing the nature of M&A.

"The talent market is loosening a little right now, amidst some economic headwinds driving hiring freezes in the industry," he said. "We don't think that near-term mergers and acquisitions will be as heavily influenced by higher labor markets."

Companies, however, "will continue to be opportunistic as valuations become increasingly attractive to expand their customer base and portfolio," Chiles added.

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