Neil Barton

Thursday, March 22, 2012

Everest call the bottom of outsourcing price declines

When, in the 60s, the British politician John Profumo denied consorting with prostitutes, one of the ladies concerned famously replied "He would, wouldn't he?" So my friends in IT consultancies and procurement will roll their eyes when they see what follows.

For more than ten years, buyers of outsourcing services have come to believe that IT unit costs will decline each year. Consultancies like Gartner, TPI/Compass, and Forrester have published research showing the amount of decline - indeed, I've written some of those papers myself.

All credit, then, to Ross Tisnovsky and Rahul Gehani at Everest, who have dared to put a contrary view. They recently published "Time to Take a Hike": Why Pricing in IT Deals Should Stay The Same, which offers three reasons why customers should pay the same or even more for their services.

Firstly, they point to underlying cost increases. They correctly point out that labour inflation is running at above 10% in some of the popular locations for delivering offshore IT services. They could also have mentioned energy costs: Keith Breed at TCL has found that data centre hosting rates have risen by 10% in the last four years, driven by more powerful servers that consume more power and the rising cost of power itself. Software licence costs are rising too, as anyone who still has an IBM mainframe will confirm.

Their second argument suggests that customers should accept inflation or COLA adjustments in recognition that labour inflation is outside a vendor's control. They put a counter argument that vendors can improve their productivity, or move offshore resources from the most expensive cities to cheaper Tier 2 cities. Both true, but worth thinking through the consequences. Improving productivity is great if it genuinely means getting the same result with less effort. Improving calls/agent/day in the Service Desk, however, clearly means shorter calls - which may not necessarily improve the service.

Their third argument suggests that service providers helped out during the 2009-10 recession by offering price reductions, and are now entitled to reap some of the benefits of economic upturns. They counter-argue that most service providers have maintained their margins, and that currency fluctuations with the rupee now favour sevice providers. In truth, I've rarely met a Procurement Director whose idea of "partnership" worked this way. The simple truth is that this argument only works as long as all the service providers bidding for your work think the same way.

But the rationale of rising costs remains strong. It's wrong to believe that Moore's Law shows that IT operating costs must always decline. The move from on-shore to off-shore delivery is something you can only do once, so it seems reasonable to expect that the pace of price decline over the last five years should now slow.

But then, I work for a service provider. So I would say that, wouldn't I?