The Hindu Business Line : Let's negotiate

European customers are becoming more demanding on the deals they outsource. They want their contracts to be renegotiated, any time during the deal, if it spells a better bargain.

THE fair wind that's been blowing on the outsourcing front is continuing. The Indian IT industry earned over Rs 1,00,000 crore in 2004-05 and India is enjoying its status as a premier outsourcing destination providing low-cost and quality-labour advantages.

But there could be a biting edge to the fair weather, especially when it comes to Europe, say industry watchers.

They say Indian vendors doing outsourced jobs for European clients face increasing pressure to renegotiate the contract, during its lifetime — on factors such as cost, completion of the project before time, service level agreements and pricing strategies.

Research firm Gartner says clients in Europe, where outsourcing as a concept is picking up, will force their vendors into more flexible relationships. Four out of five outsourcing deals will be renegotiated during the lifetime of the contract because many deals have been too focused on cutting costs, says Gartner.

A survey of 200 European executives by Gartner found that 55 per cent of businesses with outsourcing contracts have renegotiated the existing deal. The survey also found that one in eight contracts had been renegotiated within the first 12 months of operation, termed the `honeymoon' period, while only 23 per cent of companies did not intend to renegotiate their contracts.

Gartner also believes that only a few companies are keen to bring outsourced jobs back in-house.

Half of the respondents highlighted lack of flexibility as the biggest factor leading to renegotiations. Improving the supplier/customer relationship has also been cited as a key area for improvement.

Ravindra S. Datar, Principal Analyst-IT Services (India) and BPO (Asia-Pacific), Gartner, says that in the past, clients and service providers would hardly meet during the contract period. However, in future, there will be frequent review meetings to discuss possible changes in the contracts and service level agreements, whenever necessary.

For example, a vendor may currently charge his client on a `per person per hour' basis. But at a later stage, if the client realises that the same service can be provided by fewer people, there could be a renegotiation of the contract based on the volume. This will be an incentive for the client as the contract will be based on variable cost rather than fixed cost, says Datar.

"Some outsourcing deals will be renegotiated. I do not believe it will be as many as four out of five deals, particularly in an environment where pricing is showing an uptick," says G.B. Prabhat, Director, Enterprise Business Solutions, Satyam Computer Systems.

"I agree with Gartner that only very few companies are attempting to bring back in-house the work that's being outsourced, that too in the face of large mergers. Once the effects of the merger have been taken care of, these companies will actively consider outsourcing again," he says.

Are clients and vendors too focussed on cost reduction?

"Absolutely not," Prabhat says. "Clients worldwide are almost uniformly attesting that they came for cost and stayed for quality. There may be a few stray cases of quality having degenerated, as is to be expected."

The renegotiation is happening both upwards and downwards, in terms of price. For instance, it is upwards when there is a supply constraint and customers feel that the price offered to the vendor earlier is not sustainable. The price reduction depends purely on the negotiation power of the client, says Prabhat.

About 40 per cent of service recipients believe they are paying too much for their outsourced capabilities.

"Over the past four years, companies have entered into outsourcing agreements based on cost savings and short-term return on investment, with little thought given to their sourcing strategy," said Gianluca Tramacere, senior analyst, Gartner.

Exploding myths

There is a general distrust in a negotiating situation where both sides want to avoid taking any risk and each tries to dump all the risk on the other side, says Murali Neelakantan, Solicitor (England & Wales) and Advocate (India), Simmons & Simmons, London.

The worst of these situations is where the risk is not addressed at all. This is a key reason for renegotiation. When the risk not addressed in the contract becomes imminent, renegotiations begin, he says.

By far the most frequent reason cited for renegotiation is the naivete of the parties involved. Take, for instance, oft-quoted lines, such as "a good contract lies in the bottom drawer" or "a relationship of trust between the parties is dead when people start looking at the contract." Both these are myths, and are used to cover up negotiating blunders, he says.

A long-term contract ought to be crafted to last its tenure. If not, it is worthless and in many cases a major liability. It should identify all the risks, allocate them appropriately and then have mechanisms to mitigate and manage the risks. This is in the interest of both parties but, more significantly, for the customer. That's because the customer, in most cases, loses significant control once the outsourcing begins, says Neelakantan.

Lack of communication between the sales and delivery teams and between the service provider and customer are commonplace.

"I am not aware of any of the major offshore players providing any sensible cultural awareness training to their staff. Many pretend to do it as part of the human resource function by using trainers who themselves have had little or no experience of the cultural issues — just theory from text books or manuals," he says.

In sharp contrast, major service providers ensure that the teams from both the customer and service provider working on the outsourcing deal have cross-cultural training and are exposed to workshops, so as to get `a well bonded team'— not just two teams — across the table. This is evolving into a significant issue, especially in Europe, says Neelakantan.

Beyond cost-cutting

Many customers realise that outsourcing is not just about cost cutting, says Jayesh Chakravarthi, Vice-President and Head (Marketing), MindTree Consulting.

Instead, it can be an enabler of competitive advantage, provided the customers give adequate room to the vendor to focus on aspects such as risk management, change management and enhanced quality of deliverables through the adoption of standardised processes and methodologies, says Chakravarthi. These customers look to widening the scope of the contract once they gain confidence in the vendor's capability and therefore recast existing contracts.

Some contracts, especially the long-standing ones, look to renegotiate purely to revise costs downwards. In many instances, these deals are struck for years, at rates that ruled then. Renegotiation is expected to take care of disparities between current and earlier rates.

In MindTree's case, most contract negotiations have been to expand the scope of the engagement. The company's customers, such as Cendant, Volvo, and others have seen early benefits and are in the process of expanding the relationship. The expansion is in terms of volume of work, breadth of technology and type of engagement (such as consulting and fixed price projects), says Chakravarthi.

Sevice level agreements do get revised, especially in the area of application maintenance and support. As the customer-vendor relationship deepens, customers expect offshore vendors to better their performance in terms of speed and quality, year after year.

Such an expectation is justified given that a long-term relationship results in the vendor developing significant domain knowledge with respect to the customer's business and IT systems, he says.

Spelling out the do's

Gartner's advice for both service providers and recipients is:

For service providers: Ensure that propositions are compelling: either low cost or high value. Don't get trapped in the zone between being a niche and a one-shop-stop service provider. Expect prices to fall. The ability to continually reduce cost will be paramount. Automation and the right onshore/offshore balance will be key. Expect new competition.

Expect demands for increasing openness and transparency.

Develop world-class cooperation skills. Make relationship management a differentiator.

Service recipients: Regularly review your sourcing strategy. Keep exit management plans and inter-vendor transition provisions up-to-date.

Plan to spend at least 4 per cent of your IT budget on the right internal team.

Establish clear and strong sourcing governance — know who is in control. Ensure contract flexibility and alignment to business needs.

raja@thehindu.co.in

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