Why the recession isn't driving outsourcing prices down

There has been much discussion about the global economic recession's impact on the price of IT outsourcing services. The consensus has been that buyers keen to cut costs coupled with decreasing demand for IT services would drive prices down across the outsourcing market -welcome news for IT executives under pressure to slash their budgets while maintaining quality.

Indeed, according to a report from outsourcing consultancy EquaTerra, 76 percent of outsourcing service providers said that pricing pressure had increased during the first quarter-a jump of more than 30 percent from the previous quarter and last year. And while customer pricing pressure does not necessarily equal provider price slashing, Garter had predicted that IT services would decline in price anywhere from five to 20 percent, depending on the type of work, over the next year.

Gartner vice president and research director William Maurer notes that while 2009 pricing analysis is just beginning, those predicted percentages are on target thus far.

But outsourcing experts say the price decreases aren't necessarily a direct result of the recession, nor are they happening industry-wide. In some cases, prices aren't falling at all; customers are just paying for fewer or lower quality services.

"Making a blanket assessment of falling pricing levels is generally inaccurate and misleading," says David Brown, EquaTerra's managing director of financial architecture. "Prices have, in general, declined, but it's very situational to specific service providers and specific buyers."

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Reasons for Price Decreases

Some price decreases are due to process improvements and better technology, Gartner's Maurer says. Others may be attributed to current events, such as the terrorist attacks in India, explains Chris Pattacini, director of Alsbridge's ProBenchmark group. The terrorist attacks, he says, may have led to "some localized, short-term price discontinuity," but it would have been limited to transactions that were in negotiation or just about to be signed at the time of the attacks.

Pattacini adds that smaller tier two and three firms as well as Indian outsourcing vendors have been more aggressive on price "because they need to do so to keep the business, and they have little to compete on beyond price." He notes that offshore vendors have the flexibility to give up some margin and still remain profitable.

Thus, prices for offshore application development projects or testing are the most likely to have dipped over the last year. But even those prices may be impacted by other factors like exchange rates, inflation, and scope and volume of services.

"Publicly announced examples of lower prices have often been around contract labor and shorter term project work rather than longer term outsourcing deals, especially those already launched," notes EquaTerra's Brown.

Patticini agrees: "In existing outsourcing deals, pricing has not declined much, if at all," he says.

Paying the Price for Big Outsourcing Deals

One of the reasons the prices of existing, long-term outsourcing deals aren't falling is that some customers are locked into contracts that don't let them take advantage of price deflation or market trends like the global economic slowdown, says Pattacini.

What's more, many of these multi-year, multi-million dollar deals are just too complex to open up for renegotiation. And the large, multi-national outsourcers that have the most revenue tied up in such deals and carry the accompanying additional overhead expenses and higher cost structures are under pressure to maintain their own margins.

To maintain profitability and competitiveness, some of these vendors are working hard to lower their own costs by "silently and selectively" offshoring services or by substituting lower quality talent, says Adam Strichman, an independent outsourcing consultant based in Mechanicsville, Va.

In some cases, customers with longer term deals are actually paying more for IT services today.

Clients may be cutting back on IT services consumption, which means the lower prices they negotiated with the vendor for a certain volume of work, is replaced with a much higher per-unit price tag.

Customers inking new outsourcing deals with tier one multinational providers like IBM Global Services may also be drawn in by what appear to be much lower prices than in the past. But Strichman calls these "faux" price drops. The price looks lower, but in fact, the vendor has "quietly unbundled services, creating the illusion of a price drop," he says.

"Many clients and consultants miss this," adds Strichman. "They say, 'Look at the low price we got!' But, in fact, it came with less service, service that had historically been included."

Some vendors may be willing to lower their prices just to win the deal and boost the bottom line today, notes Strichman, hoping to make up the money later by reinterpreting what is and isn't actually included in the language of the document in the future.

A Better Way

So what's a cost-conscious IT customer to do? "Testing market competitiveness of IT services from IT vendors is a good business practice," says Alsbridge's Pattacini. "The market continues to change, and it is up to the client to make sure the services being purchased remain competitive."

However, putting continued unwarranted pricing pressure on the vendor is unwise. "When you press the vendor on their price, it will bite you somewhere else," says Strichman. "Guaranteed."

According to Stan Lepeak, EquaTerra's managing director of research, the potential drawbacks of pressuring vendors on price include getting lower quality service, people or resources; jeopardizing the ability of the provider to meet contractual commitments; being viewed as a less desirable client and getting less attention from the vendor; the complexity and cost of renegotiations; and delays in the completion of important projects or technology improvements.

As an alternative, CIOs under cost pressure should reevaluate the other aspects of their outsourcing deals-scope, service levels and volume. Such exercises are more likely to achieve lower costs and come with fewer unwelcome surprises than pursuing price concessions with impunity, says Pattacini.

"It is better for a buyer to pay an equitable market rate and get a quality service, but use less of it," says Lepeak, "than to drive down prices and get more of an inferior or substandard service."

Those IT executives signing on to new deals would be wise to keep that in mind as they try to negotiate the "best" price.

"There is always a lower price. No matter what price you get, another vendor can always beat it by five percent," says Strichman. "They just cut 5 percent of the services and try not to tell you where. That's the fallacy of competitive negotiations. And that last five percent that clients try to get becomes the cause of all failed relationships and troubled deals."