Tag: outsourcing contracts

Why the Focus Is Returning to Cost of Living Adjustments and Benchmarking Clauses in Outsourcing Contracts | Blog

Once standard provisions in outsourcing contracts – Cost of Living Adjustments (COLA) and benchmarking comparisons – are needed now more than ever to ensure long-term success for both parties in today’s changed outsourcing environment. With the turns over the past half-year making it a seller’s and employee’s market, these clauses can ensure enterprises capture high-quality talent without being overcharged for service delivery. To learn more about why it’s time to refocus on these provisions, read on.  

Over the past six to eight months, the global services industry has experienced a curious turn from starting the year as a “buyer’s market” due to uncertain demand and portfolio consolidation at large and medium enterprises. Similarly, the talent market was an “employer’s market.”

Fast forward to today, and the contrast could not be starker. Demand for global services has been booming. Enterprises are looking to diversify their provider portfolios. All it takes is one look at the quarterly reports of providers to see it is a “seller’s market,” while on the talent side, it is an “employee’s market.”

What is even more striking is that the talent shortage that is most visible for high-end digital skills also very much exists for other skills. It is not surprising that service providers are struggling to hold on to their existing talent even though they are rolling out salary hikes, special skills allowances, employee retention funds, etc. Further, the booming demand is forcing companies to hire at even higher compensations to fill the positions of departing employees and new openings.

Against this backdrop, it is important to also consider these few additional macroeconomic factors:

Onshore (U.S.)

  • Consumer Price Index (CPI) inflation has surpassed the 5% mark for the first time in 30 years
  • U.S. Bureau of Labor Statistics show that job openings are at an all-time high at an overall economic level

Offshore (India)

  • For the past two decades, India has consistently been a high inflation country, with CPI inflation generally ranging between 6% and 8%. Despite the high inflation, it retained a strong cost reduction proposition because of a broad trend of currency depreciation. However, over the past year, the Indian Rupee has appreciated against the U.S. Dollar. As a result, the strong tailwinds currency appreciation provided has been replaced by moderate headwinds

As a result, pricing both onshore and offshore is now trending upwards. We have witnessed service providers approaching enterprises with proposals of out-of-cycle price hikes that, in some cases, exceed 20%.

The client’s conundrum

Enterprises are facing a dilemma of whether to break the budget and pay the desired prices to service providers or risk facing shortages in quality talent and potential business disruptions.

While there are no easy answers, a few factors to keep in mind are:

  • It is widely accepted that the talent shortage is here to stay for three to five years. However, the intensity of the shortage could stabilize. For instance, in the U.S., some states are prematurely ending unemployment benefits, and COVID vaccination prevalence is increasing by the day. As a result, additional workforce might enter the job market, potentially reducing some of the demand-supply mismatch for low complexity roles
  • In India, if the Rupee returns to its depreciating trajectory, the need for higher prices could abate

Therefore, a more pragmatic, immediate approach for clients is to align on short-term pricing increases instead of agreeing to structural changes in prices that would apply for the remaining deal term. Instances where clients are already paying above fair market rates might not require any further price increases.

Contract solutions

While short-term pricing increases can be a tactical way to accommodate the pressure of price hikes, to remain aligned with the fair market prices in the medium- to long-term, it is critical for enterprises to push for the inclusion and enforcement of two key clauses: Benchmarking and COLA.

Having a balanced benchmarking clause that contractually allows for an ongoing/annual reset of prices to market standards is in the interest of both sides. It can guarantee providers do not overcharge for their services. At the same time, it can ensure that the contracted prices are not too aggressive and out-of-line with market realities, to the extent that they impact the quality of talent or services delivered by the provider.

For situations where benchmarking is not done regularly, the fallback is having a robust COLA clause that allows service providers to adjust charges on an annual basis to reflect a fair increase in delivery costs. Historically, COLA used to be present in all deals. However, in some outsourcing deals that we reviewed or benchmarked over the last couple of years, COLA had been taken out of the contract under pressure from enterprises.

While that could have been justified in a low inflation environment and a buyer’s market, in the current situation having a robust COLA clause will ensure the long-term sustainability of the contract for the enterprise as well as the service provider.

To explore how our pricing analytics services could benefit your enterprise and share your pricing experiences, contact Rahul Gehani, Partner, at [email protected].

Managing Demand Variation in Outsourcing Contracts | Sherpas in Blue Shirts

Given how long the outsourcing model has had to mature, the lion’s share of “traditional” (read: not including digital labor) contracts today are realizing the expected benefits for both buyers and providers. But when unplanned levels of variation in the internal demand for outsourced services enter the picture, serious quality, satisfaction, and cost issues can quickly rear their ugly heads.

Effective demand management – whatever the reason for the unplanned level – entails meeting internal customers’ demand and service level expectations while maintaining adequate control over the total outsourced spend.

Everest Group recommends buyers embrace three methods for managing demand variation in outsourcing contracts.

Periodic adjustment of baseline or band pricing
Buyers typically opt for baseline or banded pricing to manage volume changes. While both mechanisms provide for some demand flexibility, they expose service provider risk and trigger a risk premium in service pricing. And although volume baseline/band definition is standard in new or renewed contracts, high variation or significant demand shifts can render them obsolete. A solution to these challenges is establishment of a periodic pricing adjustment in which the buyer and service provider agree to review volume in specified periods and set the baseline at the six-month rolling average.

Appropriate outsourcing agreement structuring and clear resource unit definitions
In order for an outsourcing agreement to be mutually beneficial, the buyer and service provider need to share responsibility for demand management. Devising an agreement structure and resource unit definitions that increase the service provider’s stake in managing demand is a way to accomplish this goal. For example:

Comprehensive benchmarking of both per-unit prices and pricing metrics
When demand variation is high, or when volumes consistently increase and decrease, benchmarking per-unit prices alone can result in sub-optimal financial performance for the buyer. Comprehensive benchmarking, including both the per-unit price and the relevant pricing metrics as below, is a valuable solution.

Baseline pricing metrics

  • Dead-band range and dead-band price
  • ARC and RRC ranges and rates

Banded pricing metrics

  • Band ranges
  • Unit changes in each band

By employing these mechanisms to manage demand variation, buyers and suppliers can avoid issues in their relationship, achieve the full potential of the contract, and experience a win-win situation.

To learn more, please read Everest Group’s viewpoint entitled, “Demand Variation in Output-Based Pricing Contracts.”

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