UK public sector: tough times in a growing market

Georgina O'Toole, Senior Analyst

According to the latest analysis by Ovum's Public Sector team, the UK public sector software and IT services (S/ITS) market grew by over 11% in 2005. However, our conversations with certain suppliers revealed both a struggle to grow their UK public sector businesses and a struggle to achieve respectable profit margins. Georgina O'Toole considers why the strong market growth belies the 'tough times' being experienced by some suppliers.

The UK public sector market grew by 11.6% in 2005 to be worth £7.4 billion. Ovum estimates that growth in 2006 will be slightly lower at 9.6% and that between 2005 and 2010 the compound annual growth rate will be c9%. This will result in a market worth just over £11.4 billion in 2010. Few software and IT services suppliers would complain if they were achieving this sort of growth in their own businesses. Indeed, the growth looks particularly impressive when compared with the current and forecast performance for the UK private sector over the same period; during 2005 that sector grew by 4.0% and Ovum predicts compound annual growth of 4.3% between 2005 and 2010. Indeed, you now have to go back five years to 2001 to find a year when private sector S/ITS spending outgrew the public sector.

However, despite the seemingly buoyant market, not all S/ITS suppliers are reporting a strong performance in the UK public sector. Indeed, of the top 20 software and IT services suppliers to the UK public sector market, just nine companies achieved above-average market growth in their last financial year. Twelve companies lost market share as they failed to keep up with the rate of growth in the market - and of these, four companies saw their S/ITS revenues from the UK public sector decline.

A flat market without the mega deals

A closer look at the diverse performance of players in the UK public sector S/ITS market suggests that the mega deals are driving market growth, while small- to mid-sized IT outsourcing or project services deals are proving hard to come by. This raises the question: 'what is the underlying growth in the market, excluding the impact of the mega deals?'

Our analysis shows that, excluding the impact of the £1 billion+ deals, the UK public sector S/ITS market grew by approximately 3% between 2004 and 2005, while taking out the £100 million+ deals reveals a flat market year-on-year. This backs up our view that it is the major investments that are driving the exceptional growth in the market.

The difficult underlying market is particularly apparent in the central government and health markets where, without the £1 billion+ deals, the market was in decline between 2004 and 2005.

The situation in local government is not as severe, with small- to mid-sized IPR-led deals driving some of the growth. In defence, sector specialists continue to win mid-sized SI deals related to the Network Enabled Capability (NEC) programme and to tri-force back-office integration. This has resulted in a positive growth market below the mega deals.

Though the criminal justice market is growing, it is important to note that this growth is almost entirely driven by suppliers winning add-on work with existing long-term clients with whom a strong partnering arrangement exists. Finally, in education, it was a major deal won by Capita at the Department for Education & Skills that drove growth; the local education market only managed low single-digit growth.

The implications for suppliers

The message for UK public sector S/ITS suppliers is that although the headlines reveal strong double-digit growth in the market, the rules of the game are changing. Times are particularly tough for those suppliers reliant on small- to mid-sized deals.

In addition, all the major suppliers are pinning their hopes for future growth on the same major deals, including opportunities related to the ID Cards programme, the eBorders contract and the DCA's DISC infrastructure and application contracts. Not everyone can win, as was witnessed when the DISC contract was let in September 2006 leaving EDS and IBM to count the costs of their failed bids.

The emerging market for shared services also offers an insight into the new competitive realities. While the shared services programme has significant disruptive potential for the market, the drive will be very much towards efficiency and meeting the financial constraints of CSR07. Successful suppliers will be those in tune with the goals of central and local government, but many of the gains will come from taking market share from competitors rather than from significant new investment.

However, while the market for the mega deals is increasingly competitive, it is no time for withdrawing from the market; such a move would only store up problems in later years. Instead it is time to take a strategic medium- to long-term view of the marketplace and position for the sort of underlying growth that we are currently seeing. It also means being understanding of the changing priorities and dynamics within the public sector market. Exploiting previous investments in IT, transforming business processes, improving front-line services and identifying shared services and other efficiency gains will be the main priorities. This will only reinforce the importance of establishing and building on strong relationships with existing customers in specific sectors (criminal justice, local government etc).

Georgina O'Toole joined Ovum Holway as an analyst in August 2000. With a focus on the UK software and IT services (S/ITS) market, Georgina has spent the last four years developing her knowledge of one particular vertical: the UK public sector market.