Recession-Era Pricing is Here to Stay in Sourcing Deals
Spend Matters welcomes a guest post from Sarthak Brahma, VP and Head of Pricing Assurance for the Everest Group.
The slowly fading recession has left a profound impact on pricing in sourcing contracts. That impact is seen in a trilogy of forces with long-term ramifications that will keep pricing at recession-era levels for the foreseeable future, even as contract volume rebounds with pent-up demand. This “new normal” imparts lasting implications on future sourcing agreements.
A trilogy of forces keeping downward pressure on prices
First, starting in 2008, recessionary pressures drove pricing levels in sourcing contracts down, in many cases to unprecedented levels. Buyers focused onsustaining and improving operational baselines and pulled back on discretionary spending on new technologies or ideas.
Secondly, beginning in the second half of 2010, the market experienced a rebound in sourcing transaction volume and value. Part of this initial spending derived from pent-up, post-recession demand. Windows 7 and Office 365 rollouts, integration of smartphones and tablets, implementation of regulatory reforms, and risk management contributed to the resurgence in spending. Pricing, however, remained at low levels. While demand was booming, the prices that customers were paying per unit of consumption (per FTE, transaction, device, etc.) remained flat. The trend in BPO services pricing in India (Figure 1) illustrates the story from one of the industry’s largest service provider geographies.
Interestingly, the steady-state pricing reality did not negatively affect profit margins as some expected. Figure 2 shows how most Indian providers and offshore-centric global providers sustained (and in some cases improved) their margins even though pricing stayed at recessionary levels.
To maintain margins, providers increased Tier 2 locations for both onshore and offshore delivery. They also extended their resource hiring to second-tier graduate schools, augmenting those hires with additional training. As a result, their delivery structures flattened out with significantly more junior-level staffing. Infosys, for example, is expanding its Tier 2 seats from 32 percent to 68 percent (Figure 3).
A third major force providing downward pricing pressure is the effect of enabling technologies, particularly technologies that reduce labor costs, which account for nearly half of service provider operating costs (Figure 4).
Workforce automation, performance monitoring and reporting, and process standardization initiatives are lowering the FTE leverage requirements and, consequently, the total cost of running the operations of a delivery center. Further, cost optimization is achieved as delivery models such as cloud, virtual staffing and crowdsourcing increasingly make their way into large enterprise sourcing mandates.
Given these supply side developments, enterprises are now advancing the arbitrage proposition. Most are increasing the scale and scope of their outsourced or offshored operations. However, even though transaction activity is increasing, pricing per consumption unit remains flat and seems to have settled at the new low. Accepting the new normal and understanding the drivers behind this trend will help organizations prepare for contract renegotiations and/or new sourcing transactions.
Implications of the new normal
What are the implications of this new normal on pricing for future sourcing arrangements? In a nutshell, we will see more mature and sophisticated arrangements that go beyond cost arbitrage and towards partnerships forged on value-based objectives.
Most sourcing relationships wither on the maturity curve at the point where buyers intend to rein in the pricing and/or volumes (with a focus on greater productivity), while providers expect these to continue growing. In our experience, sustained relationships are forged when enterprises and buyers are willing to discuss value-partnering objectives separately from arbitrage mandates. Outcome-based pricing is one example, and this pricing strategy is on the rise. In the case of contact center outsourcing (CCO), for instance, we have seen an increase of 233 percent in the inclusion of outcome-based pricing structures in sourcing agreements from the 2008-2010 period to 2011-2012 (Figure 5).
Certainly, strategic partnering opportunities that directly affect enterprise businesses can lay the foundation for growth beyond arbitrage-based numbers. However, such tall expectations may fall flat if not complemented with adequate contracting. It is crucial that any sourcing contract with strategic intent in mind objectively and crisply delineate the expected outcomes. The outcomes should be measurable and attributable. And, finally, the mechanisms and caveats for sharing the realized benefits and risks should be fair and clearly inked. In the absence of this careful planning and due diligence, the best-laid plans can seldom take shape.