The new offshore outsourcing rules

A recent study finds the balance of power in offshore outsourcing relationships has shifted -- leaving customers scrambling for clout.

If you brokered a deal with an Indian offshore outsourcing provider that seems too good to be true, it probably

is.

Indian companies, forced to compete against their peers by offering services to overseas clients at rock-bottom fees, are finding it impossible to honor those contracts and have begun to simply drop clients who won't raise their payments, according to a new Forrester Research Inc. report completed by Stephanie Moore, a vice president at the Cambridge, Mass.-based firm.

Today, some top-tier Indian vendors -- many of whom have more business than they can successfully accommodate -- are shedding clients that
are too small or not profitable enough.

Stephanie Moore
vice presidentForrester Research Inc.

The report, "Buyer Beware: Tier One Indian Vendors Begin to Fire Nonstrategic Clients," said smaller clients whose contracts do not promise long-term profitability are the most vulnerable.

"Clients need to keep abreast of what is happening in order to protect themselves," Moore said. "The more we can get the word out -- the better."

Moore said clients should be suspicious today when offshore outsourcing vendors are willing to negotiate below industry-standard rates -- particularly if those vendors are among India's elite providers.

"To get high-quality service levels from top-tier vendors, customers should expect to pay in the $24 to $30 per hour range for offshore labor," the report said.

Theodore Forbath, chief strategist at Wipro Technologies in Bangalore, India, who is familiar with the report, said the company "honors all its contracts." But he did not refute all its findings, stating that Wipro rates range from those cited in Moore's report to hundreds of dollars an hour. As for smaller companies being most vulnerable to being dropped? Said Forbath: "Small companies don't come to Wipro."

"I think what we're seeing is the best Indian firms are becoming global sourcing companies, not outsourcing companies. We are getting affirmation that they like our services, and our profits reflect that," he said.

Reasons for the power shift

In the report, Moore lays out several reasons -- some of them counterintuitive -- for the changing dynamic. Indian service providers continue to grow at record pace: some as quickly as 40% per year. They also face intense margin pressure, the report said. Indian wages are rising in response to a growing demand for high-quality IT professionals. Vendors also continue to invest heavily in infrastructure to insulate themselves and their customers from the country's substandard infrastructure, according to the report. Normally, vendors would raise prices to offset costs, but competition in the Indian market prevents that from happening.

"Today, some top-tier Indian vendors -- many of whom have more business than they can successfully accommodate -- are shedding clients that are too small or not profitable enough," Moore stated.

The dynamic between vendors and clients has changed drastically in the last few years.

Between 2001 and early 2004, U.S. companies, including smaller players, became more savvy about outsourcing by hiring sourcing consultants to help establish relationships and negotiate contracts. The result was that some companies were able to negotiate very favorable terms with their vendors. But the savvy customer of a few years back, or even a few months ago, may now be the most vulnerable.

Contract woes for one customer

Moore cited a Forrester client who hired a top-tier Indian service provider to develop a part of a new system. The deal, signed in late 2004, included a master services agreement laying out rates and other terms.

Four months later, in March 2005, the vendor came back to the company, saying it needed to raise rates by 10% to make the account profitable. When the company's managing director of global outsourcing balked, the vendor said it then would not respond to any of the new SOWs.

Over a barrel, the manager agreed to the rate hike, but immediately took steps to phase this vendor out -- despite overall satisfaction with service and cost savings prior to the power play.

In the end, the vendor backed down -- but Moore's client is not interested in continuing a relationship with the provider.

The experience was troubling for several reasons, Moore said. For starters, a prestigious vendor was able to beat out other vendors with initial low rates -- but was unwilling to honor the low rates after the client had no options.

On the other hand, Moore said, the vendor was up front about its need to make more money -- and the vendor had not illegally breached the contract when it requested a rate hike.

Moore has several tips for companies outsourcing with top-tier Indian vendors:

  • To get high-quality staff and decent service levels from top-tier vendors, customers should expect to pay in the $24 to $30 per hour range for offshore labor.
  • In master service agreements, companies must include minimum turnover or rotation levels to prevent bait-and-switch as much as possible. They also must include language that specifies the seniority and experience requirements of the vendor staff.
  • Companies should include language in their contracts that prevents the vendor from declining individual work requests or statements of work, as well as from changing the rates for specifics work requests. This will make it much more difficult for the vendor to legally breach its contract.
  • Companies that are in aggressively priced contracts should be prepared to protect themselves from the questionable vendor tactics described above.

Let us know what you think about the story; email: Linda Tucci, Senior News Writer

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