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How Covid-19 has changed investment in IT Services – and what’s next for the industry

ITSM
(Image credit: Image source: Shutterstock/Tashatuvango)

Despite the Covid-19 pandemic, the IT services industry has continued to thrive through 2020 and into 2021. Even though many corporates have cut costs and stockpiled cash, IT spend has remained robust.

The pandemic, and the ensuing changes to working practices, has thrown the spotlight on a company’s IT capabilities like never before and increased demand for solutions to the new way of working. So, what is next for an industry that has propped up almost every aspect of the new corporate normal that we find ourselves in?

In many ways, remote working has opened up greater opportunities for the IT services sector to innovate and grow their market. In fact, our recent survey of UK growth businesses found that 56 percent of businesses in the IT sector thought Covid-19 had presented their business with opportunities – while 37 percent see market growth, driven by the shift to remote working, as the greatest opportunity available in 2021.

In comparison to many other industries, there is great opportunity for innovation, growth and investment in IT Services in 2021.

The shift in working patterns that has characterized the last 12 months has also demonstrated a growing gap between cutting-edge and legacy technology, a trend that existed long before Covid-19, but that has been exacerbated by the pandemic’s requirements for remote working.

Many corporates that operate on-premise solutions have struggled to adapt to remote working in a scalable and most importantly, in a secure manner, and the pandemic has therefore prompted a rapid acceleration from legacy technology to public cloud-hosted solutions.

With remote working set to be a permanent fixture of the modern workplace, we are likely to continue to witness more companies moving to the cloud, which in turn will drive demand for a number of fundamental IT services, such as cyber security and software. Companies who offer these services or can pivot their offering to tackle the new demands of business will be the ones that will thrive in 2021.

Embracing software tools

In the short to medium term, forward looking corporates will not only move their infrastructure to the cloud but will also embrace the software tools that this offers. The cloud provides a flexible, lower cost and more secure way to work throughout the pandemic, which will in turn drive productivity benefits for those firms that embrace it.

Forward-thinking companies will see this as a long-term investment into technology that will put their business on the best footing for a world of hybrid working in the years following the crisis.  

IT is now a boardroom issue for corporates, but the requisite expertise across areas such as cloud, cyber, data and AI are hard to find, and corporates will need to look to IT managed service providers to make the change from legacy to cloud-based technology possible.

Those IT service providers that have the skillset to deliver cloud hosted services and make the most of the tools available in the cloud such as modern workplace, workflow and data analytics will thrive. Legacy IT managed service providers that don’t have the skillsets or the resources to transition to suit new customer demands and preferences will wither and likely lose customers, making way for the adoption of innovative modern technologies.

Mergers and acquisitions will remain a strong feature of the landscape in 2021 and beyond. As customer relationships remain sticky in IT services, organic growth remains relatively difficult and acquisition will continue to provide a route to acquire customers, cross-sell services and realize cost synergies, making it an attractive option for successful players in the sector. The larger IT services providers have generally experienced strong cash generation, have cash to spend and appetite to invest and grow their companies. 

As a result, valuations will remain high for the right IT managed service providers: those with strong management teams and skillsets, which are providing the services most in demand to support remote work.

Technology-aware

A strong organic growth rate, low customer churn, a proven buy and build capability and IP will attract particularly strong multiples. At the other end of the spectrum, legacy IT managed service providers will generate lower multiples, albeit acquiring a customer base will remain attractive to a consolidator. So, as we see IT service providers grow exponentially during the pandemic and the gap between legacy and cutting-edge technology expand, the opportunity for M&A activity will only grow.

The market backdrop provides an attractive dynamic for investing in high-potential companies in the IT sector. And, equally, equity investment can provide businesses with funding and support to accelerate their growth. There is also strong appetite among IT services companies to utilize equity investment for this rapid growth; 62 percent of IT services providers we surveyed said that they would consider this type of investment to drive growth in their business in the next 12 months.

Retaining and attracting talent to IT services businesses will continue to remain a challenge, and given the increasing technical intensity of the solutions needed by customers, doing this effectively is critical. The sector at large has long seen demand outstrip supply for skilled talent, a trend which has only accelerated with remote working. This means that keeping the talent pipeline flowing is going to be critical for underpinning growth in the long term.

This is particularly important for consulting-led managed service providers where the quality of the technical team is key. Successful firms are doing all they can to build and strengthen a healthy corporate culture, investing in their people and putting more emphasis than ever before on flexible working and non-financial rewards to keep their teams engaged and attract new talent to their business.

The IT services industry has expanded during the pandemic, and as working patterns have shifted, it’s becoming increasingly clear how the future of work may look. At the same time, businesses are now more aware of the power of technology to help us connect and communicate. This growth in understanding, alongside heightened investment, is a trend which will far outlast the virus itself.

Mark Nunny, investor, BGF