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IT companies in quandry as clients turn against COLA

T.E. Raja Simhan | | Updated on: Feb 09, 2022

With over $35 billion in software managed services contract value due for renewal in 2 years, IT firms may sweat over cost-of-living-adjustment clause

The cost of living adjustment (COLA) clause is common in many IT managed service contracts. The clause predominantly protects the service provider from the risk of inflation. However, many clients are increasingly objecting to the clause. With over $35 billion in software managed services Annual Contract Value due for renewal over the next couple years, IT companies will have an uphill task in continuing with the COLA clause.

In fact, one of the negotiation levers used by buyers and sellers of IT services is the COLA clause, says Stanton Jones, Director and Principal Analyst, ISG. For example, if inflation increases in a country, the cost of living also goes up. Assuming there is a limited supply of qualified people there, providers in that country need to increase salaries to keep up with inflation or risk losing people to a competitor.

Buyer at loss

If a provider increases salaries without having accounted for it when the contract was signed, margins will likely suffer. The buyer typically ends up paying for this one way or another–either in increased rates via a renegotiation or in lower service quality.

The clause is linked to an index like India’s Consumer Price Index. Clients often argue why they should pay for a salary increase in a region where they don’t do business. It was the provider’s decision, in the first place, to support them from that region. Providers should be getting better over time by automating more and reducing not only the headcount to do the work but also the unit cost of each person doing the work, he added.

Prateek Gupta, Practice Director, Everest Group, says there was a decline in contracts with the COLA clause between 2018 and 2020 because of buyers’ pressure back then. During the peak of Covid, many buyers either got the clause removed from contracts or at least got temporary COLA waivers. In a few contracts, a stringent cap was being applied on COLA indexation. Operating costs for providers were largely stable during this period, which enabled providers to give in to pressure from buyers.

Says MS Prasadh, Technology Specialist, Xpheno, service providers have used COLA as a formal ticket to the negotiatin table with clients. However, proceedings at the negotiation table are subject to finding a common ground between the parties. If it is removed, it would certainly impact service providers as there would be no recourse to rising input costs, especially in multi-year engagements.

However, it cannot be denied that COLA’s relevance has got diluted as talent got pricier with shortage and enterprises shopped for talent with deeper pockets. As enterprises engaged in wage wars to acquire talent, wage movements breached boundaries and indices of cost-of-living and inflation. In a high swing remuneration climate with 2 digit wage hikes, COLA become irrelevant in recent times.

Published on February 09, 2022
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