Unearthing opportunity: Investing in IT services as the 'picks and shovels' of the AI revolution

Dan Dolev and Sean Kennedy
Dan Dolev and Sean Kennedy Senior FinTech Equity Research Analyst and Payments & IT Services Equity Research Analyst
April 9, 2024

AI is on the brink of its “iPhone moment.” Rapid technological development, growing commercial uses cases, and the integration of AI into existing business practices have pushed the technology closer to mass adoption than ever before. 

While chipmakers, cloud computing firms, and software developers have received increased investor interest for their role in powering the AI revolution, less attention has been paid to the IT services industry, a $1.3 trillion market that comprises around 30% of IT spend. Although IT services has already been increasingly outpacing global GDP annually, we expect AI’s emergence to drive another growth opportunity for the sector, estimating a $450 billion sales opportunity by 2027 for IT Services providers.

Why is the industry so well-positioned for AI? When faced with the task of implementing and managing their generative AI applications, most enterprises will choose to partner with IT Services companies due to their institutional expertise implementing complex digital technologies and familiarity with their customers’ digital architecture. 

But IT services’ greatest strength lies in its role within companies’ solution sets. IT Services encompass a broad spectrum of services and can be tailored to meet the specific needs of an organization. Unlike other established AI players – whose expertise is centered on a single part of the AI ecosystem – IT Services provide an AI investment channel that is non-vendor specific and not capital intensive. This allows investors to allocate funds across the space without making a single bet on a specific sector.

This is why we view the major players in the space – Accenture, Globant, and EPAM – as particularly attractive to investors. These firms are agnostic to the software or Large Language Models that a company uses and will serve an essential role in helping firms onboard whatever AI technology they choose – making them the “picks and shovels” of the AI revolution.

As AI grows in prominence, IT Service companies will play a key role in helping clients across industries transform their offering and adapt to the new normal. However, challenges remain in terms of labor and AI disruption, and firms that do not adapt to the pace of change will be left behind by competitors.

Why AI: IT Growth Catalysts

Even before the advent of AI, IT Services had recorded significant growth over the last decade. From 2013-2016, IT Services outgrew global GDP by 0.9%, and by 2.6% from 2017-2019. Boosted by the pandemic, this trend accelerated from 2020-2022, with IT Services growing by 8.7% annually compared to global GDP’s 2% rise (Sources: Gartner and worldbank.org). 

While this growth is substantial, the rise of AI is set to take the industry to new heights. With the speed of AI adoption accelerating at a rapid pace, enterprises that have delayed their digital transformation initiatives will need to refine and secure their digital data sets, which could lead to increased consulting spend to achieve this over the near-term. 

Over the medium-term, IT Service firms will likely play a key role in integrating generative AI into core processes and analytics including code generation, review, documentation, auto-completion, natural language processing, and security testing. Remarkably, Gartner estimates that around 90% of service providers will use generative AI for software development services – such as code compiling, optimization, debugging, and testing – compared to 26% in 2023. 

However, IT Service firms’ position as a trusted and experienced partner may be the greatest catalyst for the industry. As companies seek to grow in nascent fields – such as the metaverse, augmented reality, and machine learning – leveraging IT Services’ intellectual property and industrial expertise will be key to staying ahead of the competition. Outsourcing this work to established firms, rather than developing in-house solutions, can also enable significant cost savings and allow companies to scale up and down resources more rapidly.

Will IT be Disrupted?

While it’s clear that AI will create several growth catalysts for the industry, it’s also fair to ask whether this transformation will disrupt IT Services as a whole. In our view, looking to recent periods of disruption – such as the move to the cloud starting in 2012 and, more recently, robotic process automation/machine learning – can be helpful in determining how the industry will be affected. The good news is that in each of these cases, more software has meant more demand for IT services.

But this doesn’t mean that all IT Service firms will see equal amounts of growth. In past periods of disruption, IT Service providers that didn’t adapt to technological change became challenged, while those that transformed their services to embrace newer technologies saw greater demand for their advice, expertise, and scale.

The current rate of AI development means that IT firms must invest in their business, embrace new technology, and provide training to employees to stay competitive and ensure they are not left behind. This is why major players will thrive. Not only do these firms have greater exposure to faster growing categories, but they also have the ability to scale their offering to match industry trends and technology.

The Evolution of the IT Services Industry

The AI opportunity for IT Services is significant, and the higher complexity of data and technology in the future will drive increased workload type services for firms. Customers will need greater access to a pool of sourced and trained software developers and other specialists, which will grow increasingly scarce as demand for these services increases. 

While this transformation will spur growth for the industry, more traditional and manual business process and outsourcing services may see increased change and experience pressure due to price deflation. Some IT Services areas will also likely be “cannibalized by AI” entirely.

For example, certain product offerings – such as call centers – may no longer be needed, or replaced by AI tools that are more efficient. As a result, prices for IT services may be reduced as less labor will be required for traditional services.

Additionally, as geopolitics has grown increasingly unstable around the world, IT Service firms must make difficult choices regarding the location and composition of their workforce. For example, the Russia/Ukraine war forced EPAM to relocate around 14,000 employees into other parts of Europe, Asia, and the Americas. IT Services firms must make sure their delivery capabilities are geographically diverse in stable regions around the world. Other threats, such as a softer IT spending environment, worsening competitive pricing pressure, and employee attrition could also stall IT Service firms in their pursuit of continued growth.

However, these short-term risks are not expected to derail IT Services over the long run. Thanks to the industry’s role as the “picks and shovels” of the AI revolution, as well as the growing need for companies to leverage the industry to expand their AI offerings, IT Services is poised for further growth in the years ahead. While firms that do not adapt to change will be left behind, companies that take steps to scale their offering will realize significant returns over the next decade.

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