OutTake: How Has the Market Affected Outsourcing Pricing?
There is much speculation about how negative global economic conditions will drive down business process and information technology (IT) outsourcing prices.
by: Stan Lepeak
Dave Brown
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The premise is that outsourcing buyers, desperate to cut costs, are demanding lower prices and this, coupled with weakening demand, will drive prices down market wide. The argument is based on flawed logic. Accurately assessing the affects of market conditions on outsourcing pricing requires 1) distinguishing outsourcing from other types of third-party services, 2) understanding that outsourcing enables cost reductions, and 3) analyzing the operating models of outsourcing service providers to determine their interest and ability to reduce prices.
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Reality: Outsourcing buyers are placing increased pricing pressure on outsourcing service providers.
Seventy-six percent of outsourcing service providers polled in the 1Q09 EquaTerra Pulse survey indicated that pricing pressure increased in the quarter. This represents a jump of more than 30 percent from last quarter and last year, and is nearly double the survey average. There was near unanimous consensus from Indian service providers on increased pricing aggressiveness. Just 24 percent of service providers indicated pricing pressure remained unchanged while no providers indicated less competitive pricing conditions.
Myth: Pricing Pressure Automatically Leads to Lower Prices.
Asking for lower prices and actually getting them are two different things. Buyers face extreme pressures to reduce operating costs. Does reduced pricing actually reduce costs?
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Distinguishing Outsourcing from Other Types of Third-party Services
Buyers can reduce spend by reducing consumption levels in outsourcing efforts either directly or as a byproduct of reduced staffing levels. Reducing overall project-based and contract labor services spend is a quicker and easier way to get lower pricing than renegotiating an existing outsourcing contract. To do this, buyers ask third party services to reduce their price or perhaps they buy fewer services. Buyers can get an immediate return by reducing, deferring or cancelling discretionary project or contract labor-based services such as consulting or application development.
Continue Outsourcing versus Bringing Work Back In House
While budgets for back-office operations are being cut, this does not imply outsourcing budgets are also reduced. Outsourcing is a tool buyers have at their disposal to meet cost reduction goals rather than a budget line item. Most buyers can more easily reduce costs by outsourcing more, not less. Reduced outsourcing likely means bringing work back in-house as opposed to the work going away. This is a complex and potentially costly process that can result in the cost to perform the work going up, not down. Buyers are better served to focus on outsourcing investments that can quickly achieve maximized cost savings.
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Analyzing the Operating Models of Outsourcing Service Providers
There are additional cautions of aggressive pricing and potentially thin margins for outsourcing providers. One is that the lowest price may not lead to the best deal. Buyers are sensitive to the dangers of entering into agreements that could fail because of bad pricing. Risk mitigation relative to deal failure is more important than ever in today’s market.
Service provider restraint in deal pursuit can counter pricing aggressiveness. Providers are increasingly selective about the clients and deals they pursue. They are more closely assessing buyer risk profiles and adjusting prices accordingly (upward or downward). Service providers will place high-risk premiums on buyers in financially difficult situations who may receive less favorable contract terms and increased prices. Buyers in good financial standing will receive more attractive pricing even if their risk profiles have changed. So, while the most desirable buyers may get more favorable pricing, this does not mean providers are offering blanket market reductions.
There are structural factors that limit providers’ abilities to lower prices. Exchange rates and service provisioning locations have a major affect on pricing. Providers must still cover their operating costs, overhead, margin, risk, and inflation. They continue to look for ways to reduce their operating costs and overhead to meet their contract commitments, and continue to push price competitive policies regardless of the economy.
Conclusion Pressure on outsourcing prices has increased due to difficult economic times facing buyers. This does not mean all buyers will or should seek lower pricing or that most service providers, especially top tier firms, will agree to significant price reductions. While buyers are urged to seek the best possible pricing, it is critical to view pricing as one of several elements that define outsourcing deal value. Attention to performance, quality, and the likelihood of success are equally important.
To continue the dialogue, you can reach the authors via e-mail at slepeak@kpmg.com and djbrown@kpmg.com.
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About EquaTerra
EquaTerra sourcing advisors help clients achieve sustainable value in their IT and business processes. Our advisors average more than 20 years of industry experience and have supported more than 2,000 transformation and outsourcing projects across more than 60 countries. Supporting clients throughout the Americas, Europe, and Asia Pacific, we have deep functional knowledge in Finance and Accounting, HR, IT, Procurement and other critical business processes. EquaTerra helps clients achieve significant cost savings and process improvement with internal transformation, shared services and outsourcing solutions. In February 2011, KPMG LLP (US), KPMG Holdings Limited (UK) and KPMG International acquired the business and subsidiaries of advisory firm EquaTerra Inc. Click here to learn more about this change.
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