Stephanie Overby

It's been more than three years since HP acquired IT services provider EDS, and the long-term direction of its bigger--if not better--outsourcing business is no more clear than it was on the day the deal closed.

While HP's purchase of EDS for $13.9 billion demonstrated an appetite for the IT outsourcing business, a series of subsequent leadership changes portended a shift away from services . And HP's announcement that it will cut 8 percent of its workforce--27,000 IT professionals--by the end of 2014--up to 15,000 of them in the enterprise services division, according to a Bloomberg article--could corroborate that theory.

Watson -- IBM's Jeopardy!-playing supercomputer -- handily defeated two of the game show's strongest contestants, but can it beat cancer?

The nation's biggest health insurer aims to find out. After seeing the computer at work during the show's taping last year, WellPoint executives began brainstorming with Big Blue about Watson's enterprise potential. Its ability to answer questions posed in natural language makes it a logical match for data-driven industries. "We're dealing with a lot of unstructured data -- from medical evidence to patient information -- and that's where Watson excels," says WellPoint SVP & CIO Andrew J. Lang.

The first quarter of 2012 showed a slowdown in the value and number of outsourcing contracts awarded globally, according to the quarterly Global TPI Index, which tracks contracts valued at $25 million or more. Total contract value across functions was $18.7 billion, a decline of 22 percent from the same quarter a year ago and 35 percent from the previous quarter.

While services activity at the beginning of the year is always more sluggish than during the year-end rush to get deals done, this decrease in the number and value of IT and business process services deals was more pronounced than usual. IT contract values fell 20 percent year-over-year and 37 percent quarter-over-quarter while BPO values dropped 27 percent year-over-year and 30 percent sequentially. Typically, first quarters sink an average of 13 percent from the previous quarter.

Around this time last year, the cloud computing contract signings were coming fast and furious -- not just for commodity work like IT management or email, but for software and infrastructure closer to the core of corporate value. Not long after that, the calls started to come in to Greg Bell, principal and the Americas service leader for information protection at KPMG.

Cloud services customers more often line of business leaders that IT executive -- were panicked as they began to realize that their intellectual property (IP) was now at risk. Some, like one client who discovered that he'd potentially exposed his company's precious formulas, had to bring the software and associated processes back in-house -- at no small expense. "They quickly went through an assessment, made very aggressive movement [into cloud computing], and then had to retreat because they were not able to put the proper controls in place," says Bell.

The lure of IT outsourcing is strong -- from the promise of better service levels and lower costs to the premise of freeing up internal resources to focus on strategic business issues. And if your IT service provider -- and, let's face it, a few of your CXO peers -- had their way, you'd send it all out the door to a third-party.

Smart IT leaders understand that successful outsourcing requires a balance of internal and external skills. At a minimum, CIOs "need a sufficiently robust internal IT organization to keep the supplier honest, assist in dispute resolution and get maximum value from the relationship," says Bob Kriss, a partner and litigator in the outsourcing practice of Mayer Brown.

The IT outsourcing industry in 2011 was largely marked by smaller deals, hesitant customers, profit-squeezed providers and a whole lot of talk —but not as much action—on the cloud computing front.

Much of that could continue through the New Year —the economic uncertainty behind last year's sourcing trends is unlikely to lift until the latter part of the year. Nonetheless, the next 12 months will bring with them some new IT outsourcing trends and maybe even a few firsts. Following are 12 predictions from forward-looking outsourcing observers.

Traditional IT outsourcing customers are struggling with cloud computing, according to IT service providers and outsourcing advisors surveyed by KPMG Sourcing Advisory. IT service providers and advisors rated their IT executive customers' facility with various aspects of cloud computing on a scale of one to five, where one represented "very unskilled" and five represented "very skilled." IT executives earned embarrassing scores from their providers and advisors: None garnered even a middling score of three.

When it comes to managing and governing cloud initiatives, IT leaders earned their lowest scores from respondents: 1.69 from advisors and 2.19 from providers.

IT outsourcing deals aren't what they used to be.

The total contract value of outsourcing agreements signed during the first half of 2011 dropped roughly 20 percent compared to the same period last year, according to outsourcing consultancy TPI. IT-specific deals, which typically buoy the larger services market, were down 18 percent compared to the second quarter of 2010. In fact, large deals contributed less to the total contract value of the market than ever before, according to TPI. The shift to smaller deals had the greatest impact in the Americas where contract values were down 50 percent, both compared to the same quarter and year-to-date in 2010.

IT service providers are touting the benefits of outsourcing increasingly higher-value and more complex IT work to lower-cost locales. And IT customers still hyper-focused on cost cutting in today's economic doldrums are more than willing to consider the pitch. But Harvard Business School professors David Pisano and Willy Shih argue that "moving up the value chain" with offshoring can irreversibly damage a company's -- and a country's -- competitiveness and ability to innovate.

The two researchers made headlines with their 2009 article, "Restoring American Competitiveness," asserting that the America's relentless outsourcing of manufacturing operations had not only hurt the United States' trade balance and job prospects for its citizens, but also hindered its ability to innovate. CIO.com talked to Pisano and Shih about how their research applies to IT offshoring and what CIOs can do to retain their competitive advantage while cutting costs offshore.

The project: Become the first pro sports team to use dynamic pricing software, syncing ticket prices with demand at the San Francisco Giants' AT&T Field.

The business case: Numerous factors affect demand for baseball tickets: the time and day of the game, who is pitching, special promotions. "A Monday Pirates game is not going to be the same as a Dodger Sunday, so pricing them the same way doesn't make a whole lot of sense," says Russ Stanley, the Giants' managing vice president of ticket services and client relations.

If there were a relatively straightforward way for an IT leader to boost his company's bottom line by millions of dollars a year, chances are he wouldn't ignore it. But that's just what many CIOs are doing as a result of poor outsourcing management.

The typical outsourcing deal loses between five and 30 percent of its expected value each year through ineffective governance, according to outsourcing consultancy TPI. That lines up with the results of a survey by the International Association of Outsourcing Professionals, which found that 63 percent of companies believed they were losing an average of 25 percent of contract value due to poor governance. For a typical five-year $100 million contract, that's a loss of as much as $6 million annually.

When it comes to cutting costs, outsourcing is delivering the goods, according to the State of Outsourcing 2011 survey conducted by analyst firm HfS Research in conjunction with The Outsourcing Unit at the London School of Economics. Of 1,135 survey respondents (which included outsourcing buyers, providers and analysts), 95 percent agreed outsourcing was an effective way to reduce operational costs.

That's good news in tight times, but bottom line benefits only go so far. "A marginal improvement in a non-core process's efficiency pales in comparison to other boardroom imperatives," says HfS Research Founder Phil Fersht.